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Health Care Sector Earnings: What Might Be Expected for Q3?

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October 9, 2017
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The health care sector has been one of the better-performing sectors in 2017, bouncing back after being the only sector in the S&P 500 (SPX) to finish last year in the red. So far this year, the S&P Health Care Select Sector Index (IXV) is outperforming the SPX by 5.75% as of October 6.

The sector got a bump recently when Republicans’ released an initial framework for tax reform, with CNBC pointing out that some of the largest companies in the health care sector could be primary beneficiaries of the proposed repatriation tax break. For the sector’s upcoming earnings, analyst estimates are calling for low to mid-single-digit growth for both earnings and revenue.

Within the SPX, the health care sector is expected to report year-over-year revenue growth of 4.8% and earnings growth of 2.5%, according to FactSet, with profit margins estimated to decline from 10.3% to 10.1% across the sector. Those estimates are slightly below the sector’s estimated revenue and earnings growth rates expected for the full year.   

Beyond the proposed tax reform, below we’ll take a look at what’s been happening in the sector as companies prepare to report earnings in the upcoming weeks. 

FIGURE 1: RECOVERING FROM 2016.

After underperforming by a large margin in 2016, the health care sector has been recovering in 2017. The S&P Health Care Select Sector Index (IXV), charted above, is up 18.49% year-to-date, compared to a 12.74% increase in the S&P 500 (SPX), the teal line. The Nasdaq Biotechnology Index (NBI), the purple line, has outperformed both and climbed 25.6% year-to-date.  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.

Biotech Industry Outperforming

So far this year, the biotechnology industry has outpaced the broader health care sector, with the Nasdaq Biotechnology Index (NBI) up 25.6% versus a 18.49% increase in the S&P Health Care Select Sector Index (IXV). However, looking at 2016, the NBI fared far worse than the IXV, declining 22.01% when the latter only declined 4.37%.

Stocks in the biotech industry are notoriously volatile and it can take many years, even decades, for a company to undergo research and development, and the clinical trial process. A 2014 study by Tufts University’s Center for the Study of Drug Development found that only 11.8% of drugs that enter clinical trials end up being approved by the FDA.  

Washington on Health Care

Drug pricing scrutiny has been an ongoing focus in Congress, but there’s yet to be concrete legislation pushed forward to address the issue. Dr. Scott Gottlieb, the head of the Food and Drug Administration (FDA), recently said high drug prices are a “public health concern” and in a post on the FDA’s official blog, outlined several steps the agency is taking to make the generic approval process for complex drugs easier.

On October 17, the Senate Health Committee is scheduled to hold a second hearing as part of its investigation into high drug prices. Representatives from drug company and pharmacy benefit managers—essentially middle men between pharmacies and drug companies—have been invited to speak before the panel. Depending on how that hearing goes, there could be heightened volatility in healthcare stocks.

Due to the costly process of developing drugs, companies often go to great lengths to protect patents. Those practices have also started to come into scrutiny in Congress as well. Allergan (AGN) announced last month it had transferred the patent rights for its drug Restasis to the St. Regis Mohawk Indian Nation, which would license them back to AGN in exchange for ongoing payments to the tribe.

The tribe’s sovereign immunity would potentially shield the drug from certain patent reviews. “Allergan has argued that the legal maneuver is aimed at removing administrative patent challenges through inter partes review by the U.S. Patent Trial and Appeal Board, and not challenges in federal court”, according to Reuters. Shortly after Allergan transferred the patent rights, U.S. Senator Claire McCaskill quickly announced she had drafted a bill to prevent tribal sovereign immunity from being used to block U.S. Patent and Trademark Office review of a patent in response to the move.

Aging Demographics and More Disease as Population Grows

There are some trends that analysts anticipate to be tailwinds for the sector for years to come. One of them is aging demographics and the other is growth of certain diseases. 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 and roughly 18% of the U.S. population is projected to be 65 and older.

As world populations grow and age, certain diseases are expected to have a greater prevalence than others and a large portion of health care spending is likely to go towards them. By 2020, Deloitte projects that 50% of global health care expenditures, about $4 trillion, will be spent on cardiovascular diseases, cancer and respiratory diseases.

These trends could be a tailwind for healthcare companies, but at the same time a lot could change in the regulatory environment as well as with the treatments available in the years ahead.      

Looking Ahead to Earnings

The first major company in the sector to report earnings is Johnson & Johnson (JNJ), which will release results before market open on Tuesday, October 17. The following companies report later in the month: Eli Lilly & Co. (LLY) before market open on Tuesday, October 24, Gilead Sciences (GILD) after market close on Thursday, October 26, Merck (MRK) before market open on Friday, October 27 and Pfizer (PFE) before market open on Tuesday, October 31.

Good Trading,
JJ
@TDAJJKinahan

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