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While broad equity markets are only just approaching correction territory, the undercurrents have turned violent in the past three months, with a full swing rotation from high-growth high-multiple stocks into value and cyclical stocks on the back of rapidly rising interest rate expectations. Already, more than one-third of the Nasdaq 100 stocks are down more than 50% from their 52-week highs.
Meanwhile, the ROBO Global Healthcare Technology & Innovation index (HTEC) is down about 33% from its 52-week high, including a 19% decline in the first 18 trading days of the year. The good news is that the HTEC index portfolio is not overly exposed to the more speculative areas of the market, which are rapidly deflating. Rather, HTEC provides diversified exposure to the leaders of the healthcare technology revolution. These range from younger high-growth companies to those that are more established and profitable. While they range in cap, what they have in common is that they are the best-in-class players in the industries in which they operate.
While the index predominantly leans high-growth, which tends to warrant premium valuations (i.e. 19% of HTEC holdings trade at >10x NTM EV/Sales), it is also balanced with slower-growing innovative companies that have lower valuations, with 17% of the holdings with NTM PE < 20x. The higher valuation stocks are more concentrated in genomics and precision medicine, such as Fate Therapeutics, Editas, Arrowhead, Illumina, and Guardant Health. Those trading below 20X forward PE ratios tend to be higher cap names including Bristol-Myers Squibb, Regeneron, Philips, Roche, and Baxter.
Although the markets have pulled back, our thesis remains unchanged. With healthcare’s growing complexities and rising costs, innovation is imperative. The shortage of healthcare workers remains at a record high. Moreover, with people living longer each year, demand for automation, AI, and robotics in healthcare is stronger than ever, as companies and providers seek to digitize. For example, Novanta, which provides components for robotics and medical devices, is at an all-time high for bookings and backlog.
Vocera, the leader in healthcare device-integrated communications, has also reported record-high bookings. Last month, Vocera agreed to be acquired by Stryker, a leading med-tech company. Stryker is present at every step of a patient’s trauma experience—from the ambulance, to ER, to OR, and through discharge. By acquiring Vocera, we believe Stryker will be better positioned to integrate and streamline data throughout the patient journey. The $3 billion deal values Vocera at 10x forward EV/sales, compared to 5.4x for the HTEC index. Since the inception of HTEC in 2019, 8 index members have received takeout offers, totaling over $44.9 billion in value, including Livongo, BioTelemetry, Nuance, Varian, and Medidata Solutions.
In terms of fundamentals, there is no doubt that the pandemic accelerated the digitization of the economy, and many of the HTEC index constituents have benefited from stronger than usual tailwinds over the past two years. Technology is helping us detect disease sooner and improve treatment efficacy. The demand for these technological advancements is not slowing down, and neither are the HTEC companies that provide them. For example, HTEC genomics companies like Illumina, Natera, and Akoya have all reported metrics that exceeded investor expectations during recent conferences, including the annual J.P. Morgan Healthcare Conference in January.
We continue to expect the gains in adoption of technology to stick for the vast majority of HTEC members, with few exceptions such as vaccine and COVID-testing providers, where the surge in demand may prove transitory. In fact, many HTEC members have yet to reach new profit highs. Some areas of healthcare have been more impacted by COVID-related headwinds, such as lower non-COVID patient volumes and staff shortages that have resulted in lower capacity and delayed procedures. Indeed, orthopedic companies like Conmed and regenerative medicine companies like Axogen that depend more on patient volume have experienced deceleration over the last couple of years. That said, we do expect volumes to slingshot beyond pre-pandemic levels eventually, and we believe the market leaders will be able to weather the storm and resume their growth pace.
Overall, HTEC’s fundamentals remain strong, with a median expected sales growth of 13% (ntm), which is in line with the long-term average. HTEC’s median change on earnings revisions (pre-released during the J.P. Morgan Healthcare Conference earlier this month) remains positive.
In aggregate, we believe valuations are attractive in the context of the earnings growth trajectory. HTEC is trading on 5.4x EV/sales (ntm), a 10% discount from the historical average of 6x and 25% below its February 2021 high of 7.3x.
All companies mentioned above are members of the HTEC Index. Here are a few more recent HTEC company highlights:
- Abiomed, a leading cardiovascular medical device maker known for its heart pumps, made several important announcements at the J.P. Morgan Healthcare Conference, including the launch of a pivotal trial for Impella E-CP (Expandable), the world’s smallest heart pump at 3mm, which has been granted breakthrough device designation from the FDA. Additionally, Abiomed gained regulatory approval to begin a pilot study for their Impella BTR (Bridge-to-Recovery) device for Stage III and Stage IV heart failure patients, as an alternative to the highly invasive LVAD (left ventricular assist device). The company plans to implant the device in a human for the first time this year.
- Glaukos obtained FDA 510k clearance for its iPrime ophthalmological drug delivery device, opening new revenue streams. Glaukos also announced the initiation of a phase II trial for a patented cream-based drug formulation applied to the outer surface of the eyelid to treat Dry Eye Disease.
- Illumina, the world’s leading gene sequencing technology provider, saw sequencing instrument purchases grow 75% in 2021, and now has over 20,000 placements and 8,000 customers. The company enjoys sticky 80% recurring revenue from its complementary consumables business. Looking forward and beyond the contested GRAIL acquisition, Illumina continues plans to bring its own long-read sequencing technology to market and is making strides with multiple partnerships, including with Optum in oncology with an “Evidence Engine” and with Avenida to improve breast cancer diagnostics
- Twist Bioscience, a pioneer in DNA synthesis technology, elaborated on a novel approach dubbed “Enzymatic Chemistry 3.0” at the 2022 JPM Healthcare Conference. Twist is expanding beyond supplying DNA to pharma and research. The company is leveraging its incredible amount of proprietary data and has launched an independent biopharma company focused on infectious diseases. Twist is also exploring new use cases for synthetic DNA, including food and data storage.