Prime time to buy into healthcare, says Goldman Sachs

A relentless selloff in healthcare since June is now providing one of the better entry points into the sector in a long time, according to Goldman Sachs.

It’s been one of the more painful moves in the Australian sharemarket this year, but a relentless sell-off in the healthcare sector since June is now providing one of the better entry points into the sector in a long time, according to a leading investment bank.

In a bullish report on the ­sector, Goldman Sachs analyst Matt Ross and Tony Wu note that the Australian healthcare sector has fallen 22 per cent since early June, underperforming the S&P/ASX 200 benchmark share index by 17 per cent.

The unusually sustained sell-off in the healthcare sector began with a major profit warning from CSL in June that wiped almost 7 per cent off Australia’s largest healthcare company in a single day.

From late July, sharemarket valuations were hit by surging bond yields.

The 10-year US Treasury bond yield surged by around 100 basis points to a 16-year high near 5 per cent. Companies trading on high price-to-earnings multiples proved relatively more vulnerable.

There was also growing concern about the potential impact of GLP-1s weight-loss drugs on earnings.

The unusually large underperformance of the healthcare sector lowered its 12-month forward PE multiple to 24 times. With the S&P/ASX 200 trading around 15 times, the healthcare sector now trades at its lowest premium to the market in a decade, according to Goldman Sachs.

While the Australian healthcare sector’s premium to global healthcare remains elevated, it has more than halved to 49 per cent over the past two years, below the long-run average of 59 per cent.

“The headwinds of higher bond yields and the potential impact of GLP-1s on demand have combined to drive one of the sharpest de-ratings in the sector over the past 20 years,” the analysts say.

“In a market where quality ­defensive growth stocks are still expensive in historical terms, Australian healthcare is now the only sector in that bracket that is trading near its long-run average valuation.”

In their view, the rise in bond yields is “overdone” and risks from GLP-1s drugs are “overcapitalised”.

They do note that a weaker trend in earnings momentum has clearly been an important factor in driving the de-rating in the Australian healthcare sector. Consensus earnings forecasts for the sector for the 2023 financial year fell 11 per cent versus 5 per cent for the benchmark S&P/ASX 200 index.

It was the first time in over a decade that healthcare sector earnings forecasts fell more than earnings estimates for the broader share market in Australia.

The 2024 financial year is on track for a repeat performance in terms of the extent to which healthcare sector earnings are downgraded relative to the broader market.

However, the Goldman Sachs analysts note that consensus forecasts already assume a reversion to trend margins for healthcare stocks, so downside earnings risks are “somewhat lower now”.

And despite the weaker earnings momentum recently, the ­average medium-term earnings growth forecast of 17 per cent per annum over the next three years is slightly above the historical ­average.

Thus, on a “price for growth” basis, Goldman Sachs says the Australian healthcare sector “looks somewhat better” after the de-rating in its PE multiple. The healthcare sector’s lower returns on capital – due to a greater focus on inorganic growth – has been one increasing concern for investors.

The average return-on-equity for the sector has fallen to the mid-teens after peaking near 35 per cent in 2017. But based on the historical relationship between book values and return-on-equity, the healthcare sector still ­appears to be “trading around fair value”, according to Goldman Sachs.

“Having recently highlighted the tactical case for adding to defensive exposures into year-end, we believe the recent sell-off in healthcare stocks is providing one of the better entry points into the sector in a long time,” Mr Ross and Mr Wu said in their report.

Of the Australian healthcare stocks trading at more than a 20 per cent discount to their historical multiples, they said Clinuvel, ResMed and CSL offered the best “price for growth”.