The healthcare industry is experiencing strong tailwinds in the form of aging populations and the increasing privatisation of healthcare throughout the world. Unfortunately, the market is well aware of this and so most healthcare stocks listed on the ASX are trading at eye-watering valuations. At some point, valuations will come back to reality and I'll be waiting to pounce when they do.
Not only are these three companies set to benefit from major demographic trends, they also generate most of their income overseas and so the weak Australian dollar works in their favour. They are all defensive companies in that they provide products and services that people are reluctant to do without, making them less susceptible to economic downturns.
Sonic Healthcare Limited (ASX: SHL) specialises in pathology services and has built up large market shares in America, Germany and Australia. It stands to benefit from the shift towards greater patient monitoring and precautionary testing to improve the early diagnosis of diseases. The company has grown primarily through acquisition of pathology clinics and medical centres.
It is difficult to execute a growth by acquisition strategy but Sonic has been successful to date. However, organic growth is preferable to acquisitive growth because returns on investment are often far higher. This is why Sonic's return-on-equity (ROE) has been a mediocre 12% on average over the past four years.
The business carries regulatory risk given its major customers are public health services and also has to deal with the growing costs of its operations. There is a danger that Sonic could become squeezed as governments look to limit healthcare costs and suppliers increase prices in response to growing demand.
Cochlear Limited (ASX: COH) is the global market leader for hearing devices. This market is expected to grow over the coming decades as demand from the developing world increases and populations age. In 2014, Cochlear launched several new products which are expected to improve revenues over the near term.
Competition is growing due to the high returns on investment available and this has damaged Cochlear's margins in recent times. The business is driven by new product releases and so research and development costs are high and products have a limited shelf life. The company seeks to extend product lifetimes through periodic upgrade releases.
CSL Limited (ASX: CSL) is in an exceptional quality company. Its primary business is provision of blood plasma therapy and it also has a vaccines division. Over the past four years, revenue, earnings per share and dividends per share have all seen double digit annualised growth. Return on equity was an extraordinary 42% last year and CSL's share price has risen 150% over the past five years, which is spectacular for a $40 billion dollar company.
CSL's success is due to it being the dominant player in a favourable industry. It offers a broad range of products to its customers and has the manufacturing scale to be a low cost producer. Its financial clout means it can afford to fund an extensive pipeline of innovative treatments which eventually generate huge returns. These factors combined with its sheer size and extensive intellectual property provide it with a wide economic moat.
Foolish Takeaway
As the S&P / ASX 200 (Index: ^AXJO) (ASX: XJO) hones in on the 6,000 level, it is becoming increasingly difficult to find value. Whilst it is always advisable to buy quality companies, paying too much limits shareholder returns. Of the companies listed above, CSL is the standout performer and also the most reasonably priced in my view.
