Julius Baer's Nathalie Flury on prospects for the life-science and biotechnology sectors in 2010
Concerns over healthcare reform, coupled with a rebound in cyclical stocks and an exodus of generalist investors, led the life-science and biotech sectors to underperform markets last year.
During the second half of 2009, the healthcare reform debate reached a crescendo and it is still unclear whether reform will take place and what form it might take.
One theory is the biotechnology sector will be largely spared proposals aimed at reducing healthcare costs and the healthcare industry might even experience a net benefit should reform extend coverage to the uninsured. For 2010, important themes in the life-science area will include the healthcare reform in the US and the new importance of developing countries such as China. Greater political certainty should attract investors back to the sector, driving stock outperformance in 2010.
Positive momentum
There are at least four key demographic trends providing positive momentum to the life-science industry over the next five years. There will potentially be an expansion of prescription drug coverage, including within emerging market countries: an ageing US and European population; growth in US prescription drug volumes; and an increase in generic drug utilisation. These long-term trends – together with the anticipated US healthcare reform and a positive product newsflow, essential in the life-science industry – will not only drive life science as a whole but also on the equity level.
At a stock level, improving fundamentals, pipeline progress, potential M&A and upward earnings per share revisions are likely to benefit future share-price growth. Double-digit earnings growth is achievable for the most profitable biotech companies in 2010/2011.
Improving product pipelines should lead to sustained superior growth. In 2010, there will be more than 1,300 products in the clinical phase of testing and new approvals are expected to reach historic levels.
US
News headlines often cite the increasingly high cost of healthcare and the growing numbers of uninsured as signs the US healthcare system is in need of an overhaul. There is usually the implicit notion in these stories drug prices are also too high and need to come down. Yet the actual proposals being debated in congress include relatively few cost-cutting measures aimed at the biopharmaceutical industry.
This may reflect the fact pharmaceuticals represent a relatively small proportion (estimated at between 10% and 15%) of overall healthcare costs, and might be cost-effective relative to other forms of healthcare. On the other hand, the legislation being proposed in congress includes a plan to increase overall healthcare spending by increasing the number of insured Americans. For example, Senate Democrats on the Health Committee have proposed a plan that would reduce the number of uninsured by 16 million via subsidies to citizens. There is general agreement any major healthcare reform plan will cost roughly $1trn over 10 years.
Approximately half the cost of a plan is expected to come from cost savings while congress appears willing to make up the remaining 50% from new revenue (taxes). While exact spending estimates on any reform bill will evolve over time, it appears very likely healthcare reform will inject more funding into the system than it will extract in cost savings.
So what does it all mean for biotech companies? The various proposals contemplated in healthcare reform would likely move the dial very little. Biotech drug sales were approximately $44bn in 2009 and, assuming 5% annual sales growth, aggregate revenues for the biotechnology industry will total $585bn for the period 2010-2019. Assuming proportional benefit in line with current spending on pharmaceuticals (10%-15% of total healthcare spending), a plan that would inject at least $500bn of new funding into the healthcare system could increase spending on drugs by $50bn – $75bn over 10 years. Under the assumption biotech accounts for 15% of all drug sales, the biotechnology industry might realise an incremental $8bn-$12bn sales benefit over 10 years. Of course, these estimates should be considered with a pinch of salt in light of the lack of formalised legislation so far.
China
China is considered by many observers of the healthcare market as the next growth opportunity for healthcare and life-science companies. It is expected healthcare expenditure in China will reach $0.9trn in 2020, up from $0.2trn in 2008. This incremental demand of $0.7trn will rival that of the US in the same period. The growth drivers are fast GDP growth, an ageing population, rapid urbanisation, the rise of the middle class, increasing insurance coverage and greater access to healthcare.
Improving healthcare is a high priority for the Chinese Government, which has introduced policies to reform the healthcare system in recent years. The goals are to provide insurance coverage to all residents by 2020 (and over 90% of the population by 2011), improve industry standards and practices and expand infrastructure, especially in rural areas. In 2009, the Government committed to a stimulus package of RMB850bn ($125bn) to be implemented over three years.
Traditionally, about 46% of the medical expenses in China are paid by individuals, 20% by the Government, 30% by employers and 5% by commercial insurance. As such, only about 300 million Chinese in the major urban areas can afford Western-style medicines/therapies, leaving about one billion people, mostly in rural areas, with limited healthcare.
With healthcare reform, most patients will be treated by primary care providers in the community. The large urban hospitals should see a reduction in the number of outpatients and an increase in patients with more complex conditions. As part of the RMB850bn stimulus package, the Government plans to build 2,000 new county hospitals, 30,000 new township health centres and 11,000 new urban healthcare centres in the next three years.
Nathalie Flury is fund manager of the Julius Baer Biotech fund
