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Oct 2, 2019

Baby Boomers Fuel Growth In Healthcare Stocks: Sleep Apnea One Of Many Investment Opportunities

by Richard Morrison

Richard MorrisonThanks to growing demand from aging Baby Boomers, the investment returns from most healthcare and medical device companies have outperformed the broader stock market indexes over the past few years. Shareholders have profited by investing in companies that treat diabetes, Parkinson’s Disease, dementia, Chronic Obstructive Pulmonary Disease (COPD), osteoarthritis, osteoporosis, cataracts, hearing loss, cancer, hypertension and a host of other things we can look forward to as we age.

As one example, this past July, I spent the night of my sixtieth birthday at a sleep clinic and subsequently learned I have sleep apnea, a condition often related to age. Sleep apnea means the sleeping patient’s airway gets blocked, usually by their own tongue, and they stop breathing sometimes hundreds of times a night. These sleep interruptions can cause a myriad of health problems ranging from irritability and daytime drowsiness to heart attack and stroke. Staff at the sleep clinic said they were swamped with referrals from family doctors. Although it was hardly a scientific sampling, it prompted me to wonder if investors might benefit from the trend.

Statistics Canada says that in 2016 and 2017, the last years for which data is available, 30% of Canadian adults were considered to be at intermediate or high risk for sleep apnea and 6.4% of Canadians reported they had been diagnosed by a health care professional with sleep apnea.

In the United States, The Washington, D.C.-based National Sleep Foundation says more than 18 million American adults have sleep apnea. The condition is most prevalent among the obese, those over age 40, those with thick necks or large tonsils, a recessed chin or a family history of sleep apnea.

The most common treatment is a Continuous Positive Airway Pressure (CPAP) machine that delivers a gentle stream of air through a face mask or via tubes to the nose. The latest devices collect data on the patient’s condition and measure how diligently they use the machine, since insurers usually require the patient to use the machine regularly to qualify for a reimbursement from the insurer.

The global market for sleep apnea devices is only 20% to 30% penetrated, says a recent report by Morningstar analyst Nicolette Quinn. ResMed Inc. and Philips Respironics, a unit of electronics conglomerate Koninklijke Philips N.V., together account for about 80% of the U.S.$5 billion market. (Disclosure: I own no shares in either ResMed or Philips, but I did pay $1,210 for a Philips Respironics Dreamstation CPAP machine and await a $645 reimbursement from the Ontario Health Insurance Plan.)

In my opinion, investors can benefit by investing in medical device makers that serve Baby Boomers, the millions in developed countries born between the end of the Second World War and the mid 1960s.

ResMed Inc. (RMD/NYSE)

ResMed, based in San Diego, California, makes and sells equipment for diagnosing and treating respiratory disorders, including sleep apnea and other breathing conditions such as COPD. The company’s devices include CPAP machines, ventilators and oxygen generators, masks, humidifiers and other accessories. ResMed’s equipment collects data on patients’ breathing and sleep patterns that help doctors treat and monitor their patients’ health. The company also has a cloud-based software business.

ResMed has more than 6,000 employees and serves customers in 127 countries.

At a current price of about US$137 ResMed has a market capitalization (shares times share price) of about US$19.2-billion. From a fundamental point of view, the stock appears overvalued, trading at 48 times trailing 12-month earnings of US$2.80 per share.Over the past five years, sales have increased steadily, and after a stumble in fiscal 2018, net income has rebounded this year.

For fiscal 2019, which ended June 30, Resmed’s revenues increased 11% (13% in constant currency) to US$2.61-billion, the company said in a July 25 statement. Diluted earnings per share as defined by generally accepted accounting procedures (GAAP) were US$2.80; non-GAAP diluted earnings were US$3.64 per share.

Resmed has generally been a solid choice for investors, as an investor who put US$10,000 into the company in 2014 would today have a little more than US$25,500, dividends included.

Resmed began paying a dividend in 2012 and has increased it every year since then. At its current price, the annual dividend of US$1.56 per share yields 1.2%.

Viemed Healthcare Inc. (VMD/TSX)

For those willing to take a chance on a small-cap company, Lafayette, Louisiana-based Viemed appears a promising gamble in the growing home healthcare sector. The company’s products and services treat an assortment of respiratory diseases with a focus on COPD, serving 27,000 patients in 29 states.

Viemed has only 388 employees, and at a recent price of $8.87, the company has a market capitalization of just $334-million, making it too small for conservative investors. As might be expected with such a small company, Viemed’s share price is volatile, swinging between lows in the $4 range and $10 in the highs in the past year alone.

Medical Equipment ETFs

The S&P Health Care Equipment index is up 14.6% this year and over the past five years has climbed by an average of about 18%, vs. the S&P 500’s 10.1%, says S&P Dow Jones Indices. Here are a few healthcare exchange-traded funds that allow investors to sidestep company-specific risk while they enjoy the growth that comes with an aging population.

BMO Equal Weight U.S. Healthcare ETF (ZUH/TSX)

This fund, hedged to the Canadian dollar, was launched in 2010 and now has $319-million in assets under management. The fund holds 62 names, each with a roughly 1.6% weighting, including Idexx Laboratories Ltd., Exact Sciences Corp., ResMed Inc., Edwards Lifesciences Corp., Steris PLC, Zoetis Inc., Quest Diagnostics Inc., DaVita Inc., WellCare Health Plans Inc. and Teleflex Inc.

The fund carries a management expense ratio (MER) of 0.39%. The fund’s net asset value per share climbed steadily until 2015, slipped in 2016, surged about 25% in 2017, then slipped again last year. The fund has achieved an annualized return of 15.1% since its launch, and a very respectable 8.9% over the past five years. So far this year, the unit price is up about 11%.

iShares Global Healthcare ETF (XHC/TSX)

This Canadian fund holds the iShares Global Healthcare ETF Trust (IXJ), which in turn holds stakes in 104 of the world’s largest healthcare companies such as Johnson & Johnson, Novartis AG, Merck & Co. Inc., Unitedhealth Group Inc., Pfizer Inc., Roche Holding Par AG, Abbott Laboratories, Medtronic PLC, Amgen Inc. and Astrazeneca PLC. The fund is hedged to the Canadian dollar and carries an MER of 0.65%.

XHC’s returns climbed steadily until 2015, slipped in 2016, surged about 17% in 2017, then slipped again last year.

The fund has achieved an annualized return of 12.9% since its launch in 2011, and 7.2% over the past five years. So far this year, the unit price is up about 9%.

iShares U.S. Medical Devices ETF (IHI/NYSE Arca)

This sector ETF, which tracks the Dow Jones U.S. Select Medical Equipment Index, has US$4.3-billion in assets under management and holds stakes in 57 names. About 72% of its assets are in its top 10 holdings: Abbott Laboratories, Medtronic PLC, Thermo Fisher Scientific Inc., Danaher Corp., Becton Dickinson, Boston Scientific, Intuitive Surgical, Stryker Corp., Baxter International Inc. and Edwards Lifesciences Corp.

The fund, launched in 2006, carries a management expense ratio (MER) of 0.43%. Although past results are no indication of the future, someone who put $10,000 into the fund in 2006 would have more than $50,000 today, representing an annual growth rate of about 13.2%. Over shorter durations the results are even better.

SPDR S&P Health Care Equipment ETF (XHE/NYSE)

This fund, launched in 2011, carries an MER of 0.35% and has US$591.4-million in assets under management spread among 68 holdings, including Resmed. The fund’s top 10 names as of Aug. 28 were Nevro Corp., Insulet Corp., Globus Medical Inc., Cardiovascular Systems Inc., Conmed Corp., West Pharmaceutical Services Inc., Haemonetics Corp., DexCom Inc., Edwards Lifesciences Corp. and Cantel Medical Corp.

The fund’s cumulative total returns are about 13.8% so far this year, while annualized total returns are 4.8% over one year, 16.0% over three years, 17.8% over five years and 16.0% since its inception.

Conclusion

In my opinion, sleep apnea is one of many niche industries within the medical equipment sector whose constituent companies are likely to benefit from an aging population. That said, other investors have recognized the sector’s bright prospects as well, and after years of outperforming the S&P 500, healthcare companies and the ETFs that hold them are relatively expensive. The healthcare industry is therefore suited to risk-tolerant momentum investors who like to buy high and sell higher and who are prepared to ride out market volatility. The sector is not suitable for retirees seeking a steady stream of dividend income, nor is it a good fit for value investors who favour stocks and funds trading at low multiples to sales, earnings or book value per share.

 

Richard Morrison, CIM, is a former editor and investment columnist at the Financial Post. richarddmorrison@yahoo.ca