US Moat companies in the healthcare sector set to benefit from reform to the US healthcare system, says Torsten Hunke, Managing Director of VanEck Europe…
If the Senate passes a bill to reform healthcare, US moat companies in this sector are set to outperform their competitors. Some have argued that the proposed healthcare reform carries significant risk. Whilst this may be the case for some companies, particularly service providers to the industry, moat companies are still expected to outperform due to their long-term, sustainable competitive advantages which should hold true even in times of regulatory reform. Therefore, for moat investors, the current healthcare bill poses little cause for concern.
A company with a wide economic moat, a data point developed by Morningstar, are judged as having cultivated various competitive attributes, such as cost advantage, intangible assets and efficient scalability, which keep them one step ahead of competitors. As such, these companies are expected to provide superior long-term returns to investors. The US healthcare sector constitutes around one third of the Morningstar® Wide Moat Focus Index which tracks the performance of US-based companies with “wide moats” trading at fair prices.
The provisions of the latest draft of the healthcare bill include the elimination of several special taxes for the pharmaceuticals sector whose purpose was to finance the subsidies for “Obamacare.” Equipment manufacturers, for instance, currently pay an extra tax of 2.3 percent. Health insurance companies and pharmaceutical companies are paying similar taxes. None of these taxes are included in the new draft bill, which, if passed, could provide substantial relief for the companies concerned and impact the profit margins of their share prices.
This would be a positive signal for the pharmaceuticals sector, especially for companies with a robust competitive position, such as Allergan or Eli Lilly and Company, which are components of the Morningstar Wide Moat Focus Index. Given the high share of pharmaceuticals companies in the index, the reformed healthcare system could evolve into a performance driver for US wide moats.
In March, President Trump tweeted the intention to tighten the regulation of drug prices which briefly caused US pharmaceutical stocks to tumble. However, provisions to that effect are missing from the draft bill now under discussion, and therefore it now seems very likely that US drug makers will retain their high pricing power. Companies with high cost advantages, one of the defined attributes of a moat, particularly stand to benefit from this revision.
Of course, parts of the healthcare sector will not benefit from reform to the same extent. For physicians and hospitals, the risk of collection losses could increase if many patients suddenly lost their health insurance coverage, and with it the ability to pay their bills. This would in turn imply threats for downstream companies, such as providers of specialised IT solutions.
Once again, however, companies with strong moats are well prepared to weather the storm. For example, Cerner Group, which produces information systems for hospitals, is sure to retain its loyal client base due to the high switching costs or changing to another provider. Modern hospitals rely on customised IT solutions, and, despite the incentive of long term savings, switching to another provider would involve considerable efforts and upfront costs. The company holds a wide Morningstar® Economic Moat Rating because of this competitive advantage.
If this latest bill passes the Senate, companies within the healthcare sector which have a strong competitive advantage have no reason to worry. Indeed, proposed tax breaks cold even rather trigger outperformance. Although we see some potential negative implications for service providers, companies with so called wide moats are generally better positioned than the broader market.