Investors’ re-pricing of the sector seems detached from earnings story
Federal Reserve Chairman Jerome Powell signaled a clear change in U.S. monetary policy in testimony before Congress in late November, suggesting the Fed would accelerate the sunsetting of its monthly asset purchase (or quantitative easing) program, opening the door for interest rate hikes as early as March. While this changed the equation for risk asset valuations immediately, equity investors largely shrugged off the news and pushed stocks higher to cap an outstanding year for global equities, with the S&P 500 and the S&P Global 1200 gaining 4.4% and 4.3% in December alone, to close the year up 28.7% and 21.5%, respectively (including dividends). The 10-Year US Treasury yield meanwhile jumped nine basis points from the end of November, to close 2021 at 1.52%, hardly the spike in rates that many investors had predicted for over a year.
The reality of higher interest rates and a less accommodative Fed finally sunk in with the dawn of the new year, with growth stocks struggling out of the gate. The Nasdaq Composite and the S&P Global 1200 Information Technology both lost 5% through January 13, whereas a global benchmark, the S&P Global 1200 Index, lost only 1% during the same period. Global health care stocks have largely matched tech stocks’ decline to start the year, with the S&P Global 1200 Health Care Index sinking 4.6% also through January 13th. The MarketGrader Developed Markets (ex-Australia) Health Care Index, a selection of the best health care companies across developed markets based on our GARP selection methodology, fell almost 9% to start the year (USD, price returns), underperforming the global benchmark largely because of its equally weighted methodology. Figure 1 shows the year-to-date performance across all S&P global sectors.
Figure 1. Year to date performance for S&P Global 1200 Sector Indexes
|Index||Year-to-Date Price Return (USD)|
|S&P Global 1200 Energy Index||+12.5%|
|S&P Global 1200 Financials Index||+6.4%|
|S&P Global 1200 Materials Index||+2.4%|
|S&P Global 1200 Industrials Index||+0.1%|
|S&P Global 1200 Consumer Staples Index||-0.7%|
|S&P Global 1200 Index||-0.9%|
|S&P Global 1200 Consumer Discretionary Index||-1.3%|
|S&P Global 1200 Communications Services Index||-1.7%|
|S&P Global 1200 Utilities Index||-1.8%|
|S&P Global 1200 Health Care Index||-4.6%|
|S&P Global 1200 Real Estate Index||-4.7%|
|S&P Global 1200 Information Technology Index||-5.1%|
Weakness among health care names, however, predates recent shifts in investor expectations amid a rising rate environment, with MGDMHC peaking almost five months ago, on August 20th. The index has since entered correction territory, down 11.8% through January 13, trailing the market cap weighted global benchmarks by about 900 basis points. And while health care companies are, admittedly, not among the cheapest, their shares are not outrageously expensive by historical standards either. MGDMHC’s constituents trade currently at a median 27 times forward earnings compared to forward P/Es of 31 for the S&P Global 1200 Information Technology Index and 30 for the Nasdaq Composite. Additionally, earnings estimates for MGDMHC constituents have been consistently trending upward, lowering the group’s forward P/E ratios, and offering long-term investors an excellent entry point ahead of the upcoming earnings season. A closer look at the numbers reveals why the worst in underperformance for the sector might be behind us.
Health Care Earnings
When looking ahead at how MGDMHC might do this year, it’s useful to look at how earnings estimates for the next fiscal year have adjusted recently. MarketGrader looks daily at the degree to which a company’s full year estimates have been revised, up or down, in the last three months, as well as the magnitude of the adjustments. This analysis is a very useful complement to our GARP selection methodology for two reasons. First, as information about a company’s business is revealed in between quarterly reports (such as a new drug trial’s results or the number of vaccines sold globally, for example), analysts that follow the company adjust their models and thus their earnings projections. Since all the constituents in MGDMHC are large companies with ample analyst coverage, these ongoing revisions complement the parts of our analysis that depend purely on reported figures. Second, by looking at changes in fiscal year estimates (in addition to figures from quarterly reports), we can look past the noisier near-term earnings results and focus on longer term figures.
We therefore looked at the next fiscal year estimates for all 50 index constituents and compared them to the consensus estimate, for the same period, three months ago (for companies whose fiscal year is different from their calendar year and for which the end of fiscal 2022 is within six months, we looked at fiscal year 2023 estimates). Besides helping us gain a better understanding for how analysts have adjusted their earnings projections for these companies in the last three months, the period largely coincides with the time elapsed since the index’s last rebalance in late September. By comparing the changes in estimates to the changes in share prices over similar periods, we’re able to see if there is a significant disconnect between short-term price returns and long-term earnings projections. When large discrepancies arise between these factors, investors are often afforded the opportunity to be contrarians to the near-term consensus and pick up valuable assets at a discount.
Among MGDMHC’s constituents, only nine companies have earnings estimates for their next full fiscal year that are below the consensus estimate from three months ago. The average three-month decline for the group was -2.9%, with Moderna (MRNA) posting the largest decline among this cohort; its consensus 2022 fiscal year earnings estimate of $26.63 per share is now 10.5% below the $29.76 that analysts expected just three months ago (more on Moderna and the other Covid vaccine players below). On the other hand, forty of the index’s constituents (80% of the portfolio) currently have fiscal year estimates that exceed the consensus figures from three months ago, some by significant margins. Current full year estimates for this group are now, on average, 6.2% above what they were three months ago, with eight of the companies seeing increases of 10% or more. A single company, CSPC Pharmaceutical Group (1093.HK), has the same estimate today as it did three months ago. Across all 50 constituents, the average three-month change in next fiscal year EPS estimate is 4.4%, and since the index is equally weighted, it’s fair to say that the index’s EPS estimates for next fiscal year are 4.4% higher than they were just three months ago. Meanwhile, since the September rebalance, index constituents’ shares have declined by an average of 8.4%, which seems detached from what estimate revisions are telling us. Figure 2 shows the 10 companies with the largest changes in fiscal year estimates, both positive and negative, in the last three months.
Figure 2. Companies with the largest 3-month revisions in fiscal year EPS in the MarketGrader Developed Markets (ex-Australia) Health Care Index
|Symbol||Company Name||Market Cap||Fiscal Year||Current Estimate||Estimate 3Mo. Ago||Estimate Change|
|Companies with the 10 biggest positive changes in fiscal year EPS estimates|
|1177.HK||Sino Biopharmaceutical Limited||14,708||2022||0.08||0.06||30.4%|
|DGX||Quest Diagnostics Incorporated||19,368||2022||13.86||11.80||17.5%|
|REGN||Regeneron Pharmaceuticals, Inc.||67,348||2022||70.42||60.49||16.4%|
|LH||Laboratory Corporation of America Holdings||27,939||2022||27.53||23.98||14.8%|
|4519.JP||Chugai Pharmaceutical Co., Ltd.||53,959||2022||1.55||1.41||10.1%|
|Companies with the 10 biggest negative changes in fiscal year EPS estimates|
|1093.HK||CSPC Pharmaceutical Group Limited||14,162||2022||0.06||0.06||0.0%|
|EW||Edwards Lifesciences Corporation||76,131||2022||2.26||2.27||-0.4%|
|UHS||Universal Health Services, Inc. Class B||10,515||2022||11.74||12.00||-2.2%|
|EHC||Encompass Health Corporation||6,397||2022||4.31||4.42||-2.5%|
|COO||Cooper Companies, Inc.||20,865||2022||14.11||14.64||-3.6%|
We took our analysis a step further and calculated what we called an “estimate spread” to measure the gap between what share prices and earnings estimates are saying. While changes in share prices usually don’t have a linear relation to changes in earnings estimates, we wanted to build a metric that allowed us to see the degree to which the share prices for these companies have deviated from the changes in EPS estimates in the last three months. We simply subtracted the estimate change from the share price change to arrive at a crude “spread” between the two. The larger the negative spread, the further the stock seems to have deviated from its fiscal year EPS estimate revisions. Take Moderna, for example. As explained above, the company’s fiscal 2020 EPS estimate today is 10.5% lower than it was three months ago. The stock, though, has declined by 47.4% since the end of September, resulting in a spread of -36.8, the third highest among all index constituents. Among all index constituents only 10 have a positive “spread,” which means that only 20% of index constituents have had share price gains since September that exceed the rate by which their full year estimates have been revised over a comparable period of time. A good example here is Pfizer (PFE), whose shares have gained 28% since September, leading its full year EPS revision of 4% by 24 points. The average “spread” for all index constituents is currently -12.8, suggesting share prices are trailing full year estimates by a considerable margin. The 10 largest “spreads” may be seen in Figure 3.
Figure 3. Companies with the largest spreads between stock price performance and EPS estimate revisions in the MarketGrader Developed Markets (ex-Australia) Health Care Index
|Symbol||Company Name||Market Cap||Return||Next FY Estimate||Next FY Est. 3Mo Ago||Est. Change||Spread|
|CRSP||CRISPR Therapeutics AG||5,564||-40.0||4.89||4.65||5.2%||-45|
|BNTX||BioNTech SE Sponsored ADR||52,335||-34.8||36.49||34.81||4.8%||-40|
|1177.HK||Sino Biopharmaceutical Limited||14,708||-3.4||0.08||0.06||30.4%||-34|
|ERF.FR||Eurofins Scientific Societe Europeenne||20,894||-25.8||5.08||4.81||5.7%||-31|
|ALGN||Align Technology, Inc.||44,129||-24.0||11.18||10.96||2.0%||-26|
|DIM.FR||Sartorius Stedim Biotech SA||42,983||-22.7||8.13||7.93||2.6%||-25|
|302440.KR||SK bioscience Co.,Ltd.||13,911||-21.4||4.32||4.24||1.9%||-23|
|CRSP||CRISPR Therapeutics AG||5,564||-40.0||4.89||4.65||5.2%||-45|
Upcoming Earnings Season
While next fiscal year estimates might be useful in projecting how the stocks might do in the long-term, near-term prices will be affected by market sentiment that will be based on upcoming quarterly earnings. So, it’s fair to look at the portfolio’s estimates for the next quarterly earnings season, which for MGDMHC kicks off on January 21st when Intuitive Surgical (ISRG) reports for the quarter ended on Dec. 31, 2021. For the upcoming season, the EPS forecast is mostly a mix of positive and negative EPS growth projections, yet the average is decidedly positive. More specifically, 20 of the index’s 50 constituents are projected to report a decline in earnings per share relative to what they earned in the comparable quarter a year earlier. The remaining 30 companies are projected to surpass their prior year earnings, with 23 of them doing so by double digits. Based on current estimates for the upcoming season, index constituents are expected to see an average year-over-year gain of 29%, although this number is skewed by a handful of companies that are expected to see gains in the hundreds of percent. The portfolio’s median gain, however, over which outliers have a smaller impact, is projected to be 8.3%.
Since these figures are nevertheless still based on estimates (albeit for soon-to-be-reported earnings), what is the likelihood that companies will meet, exceed, or miss their estimates? To complement our actual earnings growth analyses, MarketGrader also keeps track of every company’s earnings surprise record on an ongoing basis. This indicator has predictive value in that companies that tend to consistently meet or exceed earnings estimates rarely report significant surprises, at least on average. MGDMHC’s companies have, in the last two years, reported quarterly earnings per share that have beaten their consensus estimate by an average of 17%. The median beat has been 13% also across the last two years (eight quarterly earnings reports). This gives us a high degree of confidence that the index’s constituents are likely to hew much more closely to their EPS estimates in the upcoming quarter than investors seem to be giving them credit for. Figure 4 summarizes the top and bottom 10 index constituents based on expected EPS growth in their upcoming quarterly report.
Figure 4. Companies with the largest expected year-over-year changes in EPS in upcoming earnings season for the MarketGrader Developed Markets (ex-Australia) Health Care Index
|Symbol||Company Name||Market Cap||Report Date||Current Estimate||Report 1Yr Ago||1Yr EPS Change|
|Companies with the largest expected gains in EPS in the next quarter|
|BNTX||BioNTech SE Sponsored ADR||53,565||4/5/22||7.67||1.15||567%|
|302440.KR||SK bioscience Co.,Ltd.||13,978||3/2/22||2.49||0.58||329%|
|ERF.FR||Eurofins Scientific Societe Europeenne||20,877||2/22/22||2.52||1.22||106.9%|
|REGN||Regeneron Pharmaceuticals, Inc.||67,923||2/10/22||19.24||9.53||102%|
|1177.HK||Sino Biopharmaceutical Limited||14,525||3/31/22||0.01||0.01||79%|
|4519.JP||Chugai Pharmaceutical Co., Ltd.||55,109||2/3/22||0.48||0.30||58%|
|Companies with the largest expected declines in EPS in the next quarter|
|UHS||Universal Health Services, Inc. Class B||10,377||3/2/22||2.87||3.59||-20%|
|FPH.NZ||Fisher & Paykel Healthcare Corporation||12,640||5/27/22||0.21||0.27||-25%|
|BIO||Bio-Rad Laboratories, Inc. Class A||20,036||2/24/22||2.87||4.01||-28%|
|DGX||Quest Diagnostics Incorporated||18,050||2/3/22||3.08||4.48||-31%|
|TMO||Thermo Fisher Scientific Inc.||246,359||2/2/22||4.87||7.09||-31%|
|4528.JP||ONO Pharmaceutical Co., Ltd.||12,336||1/31/22||0.30||0.51||-42%|
|1093.HK||CSPC Pharmaceutical Group Limited||14,155||3/21/22||0.01||0.02||-43%|
|LH||Laboratory Corporation of America Hldgs||27,063||2/10/22||5.73||10.56||-46%|
Is Vaccine Fatigue Affecting Investor Sentiment?
MGDMHC holds four of the world’s key players in the development, manufacture, and distribution of Covid-19 vaccines, namely Johnson & Johnson (JNJ), Pfizer (PFE), Moderna (MRNA), and BioNTech (BNTX). Additionally, it holds at least a dozen other names that are prominent in the global fight against Covid, including therapeutics providers, testing and diagnostics companies, and suppliers to various areas of the Covid-related supply chain. For most of these companies the surge in Covid-related business is clearly showing up in their bottom lines, including in their near and long-term EPS guidance (see Figure 5). However, what seemed like a tailwind just a few months ago has turned into a headwind as investors wonder about the durability of these earnings and in some cases the efficacy of vaccines, therapeutics, and even testing regimes in place around the world since 2020. In our view these questions are nearsighted and fail to look ahead to the opportunities created by a paradigm shift in health care globally and past the disruptions caused by the global pandemic. We think vaccines, therapeutics, and testing equipment related to Covid will be more permanent sources of revenue and profits than short-term investors seem to believe; additionally, we expect a surge in demand for non-Covid related services and procedures that were postponed or canceled during the pandemic to propel certain health care industries higher in coming quarters; we also expect that as countries rebuild and strengthen their supply chains and restock for future global shocks, health care will be a primary beneficiary; we also think that the long-term, secular, global trends underpinning health care revenues and earnings growth—namely demographics, expanding middle classes, and emerging economies catching up with advanced economies—remain intact. Lastly, we believe that mRNA technology used in the development of some of the world’s most successful vaccines, along with gene therapies, biological therapeutics and advances in computing power have ushered a new era of discovery and progress in health care that will last for decades. Investors willing to overlook recent weakness in health care stocks have an opportunity to harness this trend from pretty favorable valuations in one of the world’s leading growth sectors.
Figure 5. The Vaccine Players: Price, Sentiment*, and EPS Estimate Changes
|Symbol||Name||YTD Change||Price Since Aug. 20, 2021||Sentiment Change||Change in FY EPS Estimate|
|JNJ||Johnson & Johnson||-1.5%||-5.4%||-11.6%||+1.0%|
|BNTX||BioNTech SE Sponsored ADR||-14.0%||-36.7%||-75.6%||+4.8%|
Investors seeking to track MGDMHC in Australia may do so through the VanEck Global Healthcare Leaders ETF (ASX: HLTH)