Medtech stocks benefit as drug-pricing scrutiny intensifies

Print 04 December 2015
Lewis Krauskopf / Reuters

Investors have been moving into medical device shares as a safer play in the healthcare sector amid concerns that intensifying scrutiny over high U.S. prescription drug prices will continue to weigh on pharmaceutical and biotech stocks.

Shares of medtech companies such as Edwards Lifesciences , Boston Scientific and Becton Dickinson have outperformed the broad healthcare sector, and especially pharmaceutical and biotech shares, over the past two months since U.S. presidential candidate Hillary Clinton tweeted she planned to address specialty drug "price gouging."

Clinton's tweet was a watershed moment that shook the sector. Many on Wall Street expect the political and media scrutiny on pricing and healthcare costs to stick through the November 2016 election. Just on Tuesday, a U.S. senate report zeroed in on the costs of Gilead Sciences' blockbuster hepatitis C drug.

While some investors may flee healthcare altogether to avoid any political risk, others see medtech as a preferred alternative to those seeking exposure to the sector.

"They may not be completely safe, but I think there is less risk with the device companies than with the big biotech and pharma companies," said George Strietmann, a portfolio manager with Cincinnati investment advisory firm Bahl & Gaynor.

He said he likes Medtronic, Stryker and Becton Dickinson and his firm is underweight biotech and pharma stocks in its growth portfolios, but overweight medical technology stocks.

Since Clinton's tweet, the S&P 500 Health Care Equipment index, which includes large medical device companies, has climbed more than 5 percent, against a 1.5-percent increase for the S&P 500 healthcare index.

Medtronic, Baxter International and Abbott Laboratories have also gained at least 4 percent. Diagnostic equipment companies such as Thermo Fisher Scientific and PerkinElmer climbed sharply over that time.

Conversely, the Nasdaq Biotechnology index has fallen more than 5 percent since Clinton's tweet. The NYSE Arca Pharmaceutical index is down more than 2 percent, dragged down by poor performance of specialty drugmakers such as Valeant Pharmaceuticals and Mallinckrodt that have been criticized for pricing practices and targeted by short sellers.

Other factors could be driving the diverging stock performances beyond the political pressures, and Morningstar analyst Debbie Wang pointed to a solid third-quarter earnings season as helping device companies.

But RBC Capital Markets analyst Glenn Novarro said his phone has been ringing in the wake of the drug pricing publicity.

"Based on the incoming call volume, there's greater interest in medtech today than earlier in the year," Novarro said.

Prices for commonly used branded drugs more than doubled from 2008-2014, according to benefit manager Express Scripts . Price tags of $100,000 or more for new therapies for cancer and other conditions, as well as recent massive increases on old medicines put the industry in the spotlight.

Meanwhile, prices for medical devices such as stents, pacemakers and knee replacements have fallen 2 percent to 3 percent annually over the past five years, according to RBC's Novarro, as hospitals seek to cut their costs.

Investors and analysts pointed to several favorable factors for investing in medtech, including an aging U.S. population and increased demand from growing middle classes in emerging markets. Recent acquisitions, by companies such as Medtronic and Zimmer Biomet Holdings, stand to benefit those companies and could be a prelude to further consolidation, Novarro said.

But the lack of pricing power also could be seen as a negative sign for the medical device industry, potentially reflecting a lack of significant innovations.

"I really don't see a whole lot of product differentiation" in areas such orthopedics and interventional cardiology, said John Fraunces, co-manager for the Turner Investments medical sciences fund in Berwyn, Pennsylvania.

Any bump that medtech shares get on worries about a clampdown on drug pricing may not last - and the worst fears of pharma pricing limits may never be realized.

"It's more of a headline risk than a real risk," said Jason Ware, chief investment officer at Albion Financial Group in Salt Lake City. He said his company remains overweight in biotech, preferring the growth outlook for companies such as Gilead, with its revolutionary but expensive hepatitis C treatment, over the medtech sector.

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