The return of demand for non-acute health-care services appears to be directly tied to the improvement in the macro environment. A fairly muted economic recovery and stubborn unemployment levels have so far successfully suppressed any sort of pickup in demand for health-care services (particularly against the backdrop of the easy comps of 2010).
Most healthcare firms should still post positive top-line growth in the second half of the year, buoyed largely by easy comps and a weak dollar. The latter dynamic is particularly favorable for multinationals with a large fixed cost base in the U.S. While this top-line expansion is somewhat artificial, it is also needed for a sector desperate for growth. With valuations once again attractive (as momentum has been sucked out of the sector), even a mild uptick in revenue is welcome news. However, a broad economic improvement will remain the key catalyst for health-care stocks.
M&A Activity Should Boost Stock Prices
In prior quarters, the healthcare sector saw a number of midsized acquisitions in the pharmaceutical and life science space.
A key determinant for M&A activity in most other healthcare industries remains the relative health of balance sheets of potential acquirers. Healthcare firms are flush with cash, and with free cash flows for most firms in the billions and balance sheets relatively debt-free, consolidation activity in the sector is unlikely to be deterred by the uncertainty surrounding capital markets. Arguably, as the sector as a whole experienced rapid valuation deterioration over the past month, we may see share buybacks accelerate as firms take advantage of depressed prices. However, acquisitions remain a vital component of the growth strategy, so even with a pickup in share repurchases, the M&A environment will remain active. Smaller biotechs, as well as life science and diagnostic firms could be potential acquisition targets.
Alex Morozov is the director of the healthcare team at Morningstar.
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