May 2023 / VIDEO
Medical Technology Industry Well-Positioned Post-Covid
- Many businesses in the health care sector can consistently grow revenue and earnings, even in challenging macroeconomic environments.
- The medical technology, or medtech, industry is one area of health care that we believe is particularly well positioned for the near term.
- We prefer health care firms with high recurring revenues from consumables and services as opposed to those that are reliant on sales of capital equipment.
A variety of unique subsectors make up the health care sector, with business models ranging from pharmaceuticals, where companies are developing cutting-edge medicines to treat cancer, inflammatory diseases, and other conditions, to the consumer-facing hospitals and providers that are delivering clinical care to patients.
The common thread across the health care sector is that many of these businesses can consistently grow revenue and earnings, even in challenging macroeconomic environments. With the potential for a recession looming, this characteristic may prove valuable.
There are two primary reasons for this resilience. First, demand for health care is noncyclical—it is one of the last areas where consumers cut spending when times get tough.
Second, secular demographic trends support health care demand. Since 2010, the percentage of Americans 65 and older has grown rapidly, driven by the aging of the baby boomer generation; rising life expectancy should support the continuation of this trend. According to projections as of February 2020 from the U.S. Census Bureau, by 2060 nearly one in four Americans will be 65 or older, up from 13% in 2010 and 17% in 2020.
Of course, utilization of the health care system increases with age, with people age 65 and over spending much more per capita on health care than younger cohorts. A 2021 study by the Kaiser Family Foundation found that people 65 and over accounted for 35% of health care spending despite making up just 17% of the U.S. population. The secular growth of this demographic should drive increased demand for prescription drugs, medical devices, and health care services for years to come.
The medical technology, or medtech, industry is one area of health care that we believe is particularly well positioned for the near term. The last few years have been unusually challenging ones for medtech, where these businesses lagged their earnings potential due to a combination of factors largely outside of their control.
Medtech companies saw a sharp decline in revenue and earnings early in the pandemic as health care systems around the world deferred all but the most urgent medical procedures in order to preserve capacity and resources for COVID patients. For their part, patients, wary of COVID, avoided interactions with the health care system.
Even as patients slowly returned to the system, procedure volumes remained stubbornly below pre-COVID levels through 2021 and most of 2022 due, in part, to staffing shortages that prevented health care providers from catching up on all of the deferred procedures. At the same time, supply chain headwinds and input cost inflation put downward pressure on medtech companies’ profitability.
However, we believe the medtech industry is now well positioned to rebound from these difficulties. Procedure volumes are normalizing as hospital staffing shortages have started to ease, which should support healthy organic revenue growth.
Easing cost pressures for raw materials and freight alongside operating leverage should drive margin expansion starting in the second half of 2023.
It is important to note that not all medtech companies are created equal. In weaker economic environments, hospitals tend to reduce capital spending on large-ticket items. This phenomenon drives our cautious view on companies that are overly reliant on sales of capital equipment and our preference for those with a high mix of recurring revenues from consumables and services.
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