In 2016, healthcare was the only sector in the S&P 500 (SPX) that ended the year in the red, declining 2.7% versus a positive 12% return for the SPX. However, things appear to be looking up in 2017 with the sector up 7.8% at the end of March heading into Q1 earnings—trailing only tech and consumer discretionary. Despite the sector’s performance year-to-date, or YTD, the earnings picture doesn’t seem to be as optimistic.
Healthcare companies in the SPX are expected to grow earnings only 0.5% year-over-year in the first quarter, versus 9.1% for the broader index, according to FactSet Research. For the rest of 2017, FactSet expects healthcare earnings to pick up and grow 4.2% for the year versus the SPX’s estimated 9.8% earnings growth.
Over the next month, we’ll see earnings from healthcare giants like Johnson & Johnson (JNJ), Eli Lilly (LLY), Pfizer (PFE), and Merck (MRK). JNJ reports on April 18 with consensus third-party analyst estimates of $1.76 earnings per share, or EPS, on revenue of $18 billion. JNJ was one of the few major healthcare companies to beat the SPX’s return in 2016 and the stock is up about 8% since the start of the year. LLY is expected to report April 25 with consensus analyst estimates of $0.95 EPS on revenue of $5.23 billion. LLY finished 2016 down 12.7% versus the SPX’s 9.5% gain, but the stock has made up ground in 2017 and is up 14.8% since the start of the year—helped by Goldman Sachs upgrade from neutral to buy in late-2016 on its promising pipeline.
Both PFE and MRK are expected to report on May 2. Q1 consensus analyst estimates for PFE are $0.67 EPS on revenue of $13.02 billion while MRK is expected to report $0.83 EPS on revenue of $9.32 billion. MRK is beating the SPX so far in 2017, while PFE’s performance has lagged. Figure 1 below shows JNJ, LLY, PFE and MRK’s YTD performance.
Politics in Focus
After failing to repeal and replace the Affordable Care Act, or ACA, investors might be more skeptical of House Republicans’ and President Trump’s ability to deliver on other reforms like taxes. While changes to the ACA would have varied impacts on the healthcare sector, lower corporate taxes should benefit many companies. President Trump has also hinted at a tax holiday that would allow companies to repatriate profits back to the United States at lower tax rates. This could have an outsized impact on some of the larger healthcare companies holding billions in cash overseas. Companies could use these potential tax savings to invest in growth, acquire companies, and boost buybacks and dividends.
There are some concerns Washington’s focus on drug prices could negatively impact healthcare companies. Ethan Lovell, with Janus Captial Group, isn’t too worried. In an interview with Barron’s, he said “At the end of the day, the people in charge in Congress do not see drug-price controls as a solution. Elected officials would break new ground if they tried to regulate drug prices beyond the scope of the programs they control or fund through the federal budget.” Regardless of changes to drug pricing, negative scrutiny isn’t good for any company.
M&A in the Healthcare Sector
Mergers and acquisitions, or M&A, have been slowing down in the past several months. From December through February, M&A deal volume in Health Services and Health Technology was down roughly 21% compared to the same period a year ago, according to FactSet Research. Even though deal volume was down, deal value was up $55.66 billion. Some analysts think this trend could continue as large healthcare companies look for companies with promising drug pipelines.
Right now, a lot of focus in the markets is on tax reform, but it’s impossible to say what will happen and when in terms of policy changes. The healthcare sector has rallied in 2017, but there are potential catalysts like tax reform and drug pricing scrutiny that could affect stock prices in the future.