Investing in healthcare in a post-Covid world

Last week my colleague Matt wrote a short piece on the risks of investing in the many small pharmaceutical businesses rushing to find vaccines, treatments or tests for coronavirus.

We think these kinds of moonshot investments are too risky to form more than a tiny part of most portfolios. However, that doesn’t mean investors should dismiss the healthcare sector altogether.

The current crisis has shown how resilient the industry can be and we think there are several more established names that’ll play a crucial role in the future of healthcare, both in the UK and internationally.

This article is not personal advice. If you’re not sure if an investment is right for you, please speak to a financial adviser. All investments rise and fall in value, so you could get back less than you invest. Past performance is not a guide to the future. Yields are variable, not guaranteed and not a reliable indicator of future income.

EMIS – digital doctors

EMIS develops software for GPs practices and pharmacies. Its products connect different healthcare services, help maintain patient records, book appointments and manage medicine supplies.

The group operates a software as a service model (or SaaS in industry jargon). In return for a regular fee customers receive regularly updated software and support.

At the end of the last financial year EMIS customers included 57% of UK GPs, 21% of community pharmacies and 23% of A&E units – having gained market share in the latter two segments. Given the complexity of changing IT providers, it’s perhaps no surprise customers tend to sign up to long term contracts, and often prove very sticky.

Software development is expensive, time consuming and needs significant expertise. However, adding new customers is essentially costless. That should boost EMIS’ margins as the company grows and also means the vast majority of profits convert into cash – both excellent qualities in the current climate. Historically that’s driven steady dividend growth, which now represents a 3.2% prospective yield – although past performance is not a guide to the future.

As you might expect EMIS’ products have been at the heart of the UK’s coronavirus response. The group has made certain services available to customers free of charge – including video consultations – and rolled out coronavirus specific functionality. However, the cost of doing so is minimal and full year profit expectations are unchanged.

We take further comfort from the fact there’s net cash on the balance sheet – which at £44.1m has actually increased since the start of the year. That should give some shelter in the event that coronavirus does rock the boat and also helps underpin investment in a bulging pipeline of new products.

The group’s also looking outside the NHS for future growth – a sensible decision since overreliance on a single customer creates a risk that competitors muscle in and decimate the revenue stream. CEO Andy Thorburn wants the private sector to eventually contribute 50% of EMIS' revenues, and has his eye on opportunities in the medicine supply chain and expanding the direct-to-patient offer.

We think the current crisis has been a perfect illustration of EMIS' long term strengths. While the shares currently trade on a price to earnings ratio of 20.6 times, a little above the longer run average, we suspect digitisation in the health service will only increase from here. EMIS is well placed to support that process.

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Primary Health Properties – specialist surgeries

Like EMIS, Primary Health Properties (PHP) provides services to GPs surgeries and community pharmacies. However, in PHP’s case that’s in the form of purpose built GP surgeries – often with facilities for pharmacies and other community health services attached.

The group operates a portfolio of 510 properties across the UK and Ireland. 90% of the £133m annual rent roll is ultimately funded by the UK or Irish health service – and governments tend to be pretty reliable tenants. Some property companies collected less than 50% of the rent due to them in the second quarter of this year as coronavirus struck. PHP collected 97% of Irish rents and 98% of rents in the UK.

Strong demand for the group’s properties and good asset management, with PHP expanding properties to meet occupiers changing needs, have helped the group grow rents over time. Together with selective acquisitions that’s helped the group deliver 23 consecutive years of dividend growth, and the shares currently offer a 3.9% prospective dividend yield.

We suspect the current crisis will only increase demand for PHP’s purpose built community healthcare properties, and the group recently raised £140m to deliver on that demand. There's a healthy pipeline of enhancements to the existing estate and new facilities lined up, potentially securing revenue growth for years to come.

There are some reasons for caution too though. Loan-to-value (LTV) is high by industry standards. A high LTV means an uptick in interest rates or widespread increases in rental arrears would be painful – although neither look likely in the short term. The recent placing has also reduced debt, and it's good to see the group cut its upper limit for debt from 55% LTV to 50% LTV. But it's a risk nonetheless.

It’s also worth noting that as a REIT (real estate investment trust) PHP is likely to ask investors to fork out extra cash from time-to-time. REITs legally have to pay out most of their profits as dividends, making it's difficult for them to fund growth without issuing new shares.

However, in our opinion the main reason for caution where PHP is concerned, is valuation. The stock is priced well above the book value of its assets. While PHP remains interesting for income seeking portfolios, it’s particularly important investors take a long term view, and are prepared for some ups-and-downs along the way.

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Novo-Nordisk – dealing with diabetes

Novo-Nordisk was one of our five shares to watch for 2020. We’re pleased to say the group has weathered the Covid-crisis rather well. But that’s got more to do with its fundamental strengths than any involvement in fighting the virus.

The Danish listed group manufactures nearly half of all insulin worldwide, and accounts for 29% of all diabetes treatment sales.

Diabetes is a chronic rather than acute illness, and potentially fatal if not managed correctly. Patients will have to inject insulin and live with the illness for the rest of their lives – this gives Novo-Nordisk a regular and predictable revenue stream. Prevalence is also increasing – with the global percentage of adults with diabetes rising from 4.7% in 1980 to 8.5% in 2014. That rise is linked to increasing wealth in emerging markets, a trend that looks set to continue.

However, Novo has been branching out of straightforward insulin in recent years, and it’s these new drugs that are really turbocharging sales. Recently launched GLP-1 drugs are specifically designed to treat type-2 diabetes. These drugs work by imitating a naturally occurring hormone which stimulates insulin production and delays sugar release into the blood. That avoids the injection of insulin straight into the body and reduces the risks of dangerous complications.

The recent Rybelsus launch has the potential to turbo-charge sales in the short term – as the only GLP-1 product in tablet form (rather than injectable). The group's knowledge of GLP-1 treatments also led it to develop new obesity treatments.

It's not all smooth sailing though.

Insulin pricing is under pressure in the US, with a backlash against the high price of an essential drug. That led to a 24% decline in US insulin sales in the first half of this year. However increasing emerging market demand – particularly in China – has offset a lot of that headwind.

We also have some lingering worries that cash strapped health services will emerge from the current crisis unwilling to pay the high prices pharma companies demand for their drugs. That could undermine what have until now been attractive operating margins of well over 40% for Novo.

Those headwinds might explain why the group has a significant net cash position. That’s relatively unusual for a pharmaceutical company – and very different to UK names AstraZeneca and GlaxoSmithKline. We’re not sure the caution is necessarily needed, but it’s certainly no bad thing.

Overall though we still think Novo offers investors something distinctive and attractive. Pharmaceutical companies with net cash on the balance sheet, a defensive end market and prospective dividend yield of 2.3%, are few and far between.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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