As earnings season gets underway, companies in the healthcare sector report Q2 earnings in the next several weeks. What might be expected from the sector?
After a lackluster performance in 2016, the healthcare sector appears to be making a comeback in 2017. So far this year, the S&P 500 Healthcare Select Sector Index (IXV) is up 14.2%, compared to a 7.7% year-to-date increase in the S&P 500 (SPX). That rally has likely been helped by improving revenue and earnings.
In the last quarter, 83% of healthcare companies in the SPX reported earnings above analyst estimates, according to FactSet, and 73% reported revenue above estimates. Granted, the bar was pretty low with earnings only expected to grow 0.5% year-over-year in the first quarter. For the full year, FactSet estimates project healthcare earnings to grow 4.6% year-over-year, compared to 9.8% earnings growth for the SPX.
At the company level, expectations vary greatly as earnings have been pressured by patent expirations, generic and biosimilar competition, and the U.S. dollar (many of these companies generate large portions of revenue overseas and exchange rates can impact profit margins). For Q2 2017, Johnson & Johnson’s (JNJ) earnings are expected to increase 2.9% to $1.79 per share, according to third-party analyst estimates. Looking at those same estimates for some of the biggest pharmaceutical makers, analysts have said they expect Eli Lilly’s (LLY) earnings to increase 19.7% to $1.03 per share, Bristol-Myers Squibb’s (BMY) earnings to increase 5.8% to $0.73 per share, and Merck’s (MRK) are expected to decline 6.5% to $0.87 per share.
In addition to patent expirations, competition, and a strong U.S. dollar, there are other broad factors that could affect the sector: an aging population, drug pricing and politics, and mergers and acquisitions.
FIGURE 1: RECOVERING FROM 2016.
The S&P 500 Healthcare Select Sector Index (IVX) is up over 14.2% so far this year, compared to a 7.7% year-to-date increase in the S&P 500 (SPX). In 2016, the IVX underperformed the SPX by almost 14.5%. Chart source: thinkorswim® by TD Ameritrade. Data source: Standard & Poor’s. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.
Approximately 10,000 baby boomers turn 65 every day, according to Pew Research, and that trend is expected to continue until 2030, when the last of the boomers reach retirement age. At that point, Pew projects roughly 18% of the United States population will be 65 and older. While this trend could be a tailwind for healthcare companies, a lot could change in the regulatory environment as well as the treatments available, making it challenging to predict the effects in the upcoming years.
Some of the public and government scrutiny of drug pricing has abated and attention appears to have shifted towards ongoing efforts in Congress to change the Affordable Care Act. When news regarding these two things has come out over the past several quarters, traders have reacted quickly, contributing to intraday price swings in healthcare stocks. Ultimately, any changes to drug pricing controls and the Affordable Care will take a while to play out and the impact is likely to vary from company to company.
Some analysts have said they expect mergers and acquisitions, or M&A, activity in the healthcare sector to pick up in upcoming quarters, potentially driven by low interest rates, large amounts of cash on balance sheets, and the need for larger firms to continue developing blockbuster drugs to fuel revenue growth.
Over the past year, there have been several major acquisitions. Pfizer (PFE) announced it would acquire Medivation for $14 billion and Johnson & Johnson (JNJ) is in the process of acquiring Actelion for $30 billion. In addition to M&A, companies are pursuing joint ventures to access drug pipelines. One of the most recent deals was Celgene’s (CELG) announcement it will acquire a stake in BeiGene (BGNE) and help develop and commercialize BGNE’s cancer treatments.
JNJ is the first major healthcare company to report earnings on Tuesday, July 18 before market open. In the following weeks, reports are expected from: LLY on Tuesday, July 25 before market open, MRK on Friday, July 28 before market open, and PFE on Tuesday, August 1 at 10:00AM Eastern Time.
Good Trading, JJ @TDAJJKinahan
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