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These out-of-favour healthcare shares could rebound in 2018

Credit: Unsplash

The healthcare sector has been in hot demand in 2017 for its growth potential and relatively dependable income streams, but there are a few medical services providers who were left far behind in the mad market rally.

I won’t blame you if you can’t name any of these losers as sector heavyweights like CSL Limited (ASX: CSL), Ramsay Health Care Limited Fully Paid Ord. Shrs (ASX: RHC), ResMed Inc. (CHESS) (ASX: RMD) and Cochlear Limited (ASX: COH) have dominated the spotlight.

But one group of laggards may be poised to make a big comeback this year as their operating outlook has improved to a point where their valuations are getting too hard to ignore.

I am referring to the embattled In Vitro Fertilisation (IVF) providers who have recorded steep losses over the past 12-months when the S&P/ASX 200 Health Care (Index:^AXHJ) (ASX:XHJ) index has outperformed the broader market.

 

Source: Yahoo Finance

The latest Medicare data from the government is giving optimism for a rebound in stocks like Virtus Health Ltd (ASX: VRT) and Monash IVF Group Ltd (ASX: MVF). The November Medicare market growth for IVF came in at 7.9%, versus diagnostic imaging at 6.9%, and pathology at -0.2%.

Given that Virtus slumped 16% and Monash is nursing a 25% tumble over the past 12 months, I think value is returning to the sector.

Morgan Stanley is also optimistic about the outlook for both stocks, although it favours Virtus over Monash at this stage.

The broker notes that the circa $5 million in cost savings targeted by Virtus in its restructure will contribute more than half of the $8.8 million increase in the company’s earnings before interest, tax, depreciation and amortisation (EBITDA) the broker is expecting in FY18.

The stock is also trading at around a 13 times price-earnings (P/E) and that is cheap in the broker’s opinion when you consider that Virtus’s mid-teen earnings growth, circa 5% fully franked dividend yield and its dominant position in the industry.

Monash has many similar qualities to Virtus, but the broker is a little less bullish on the stock because new managers are transitioning into the business, it has a lack of exposure to the faster growing budget IVF market segment, and there are worries about doctors who left the group who are coming off a non-compete period in FY19.

Nonetheless, Morgan Stanley has an “outperform” recommendation on both stocks with a price target of $8 on Virtus and $2.20 on Monash.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Cochlear Ltd., Monash IVF Group Ltd, Ramsay Health Care Limited, ResMed Inc., and Virtus Health Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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