Medical-Device Stocks Rise As Pressure Ebbs, But Risks Remain
June 24 2009 - 1:15PM
Dow Jones News
As the push for U.S. health-care reform increasingly looks like
a long and difficult process, pressure may be lifting on
medical-devices stocks battered by worries that reform efforts will
damage business.
The sector also is benefiting from a weakened U.S. dollar, which
helps overseas revenue, and tepid signs of economic recovery.
Plenty of uncertainty remains, and shifting reform winds could
quickly alter investor perceptions, but some observers believe the
device sector's fortunes will improve as the year continues.
"I do think you could see these stocks become gradually more
attractive," said Rick Wise, who covers device companies for
Leerink Swann.
That process appears underway already, albeit modestly. Two Dow
Jones Wilshire indexes tracking medical-device companies posted
small gains last week while outperforming a declining Standard
& Poor's 500 index. That improvement followed a long stretch,
dating to the broader market's bottom in early March, in which
device stocks didn't keep pace with the broader market's sharp
rebound.
According to J.P. Morgan analyst Michael Weinstein, "investors
have begun to appreciate the challenges facing Congress and the
likelihood that any bill that comes out of Washington is watered
down in compromises and potentially lacking in teeth."
Fear the device sector would be bitten triggered sharp stock
declines over about a month between February and March. The plummet
was exacerbated by the Obama administration's proposed fiscal 2010
budget that showed plans to clamp down on medical spending, even
though there was no precise threat to device companies.
With sentiment now improved, Weinstein said he expects a
second-half rally in health-care stocks in general and
medical-technology stocks in particular.
"Suddenly people just realized, hey, this could be delayed, it's
not going to be as bad as we feared, [and] there's probably going
to be a more measured approach," said Matthew Loucks, a portfolio
manager with Sit Investment Associates in Minneapolis, which owns
shares of several health-care companies.
The ranks of major device companies include Medtronic Inc.
(MDT), Boston Scientific Corp. (BSX), Zimmer Holdings Inc. (ZMH)
and St. Jude Medical Inc. (STJ). Conglomerate Johnson & Johnson
(JNJ) also has a huge devices business.
Despite recent hints of optimism, big unanswered questions leave
reason for continued caution. Analyst Wise said he's reminding
people "that there are still issues on the table that we have to be
sensitive to."
Tax reform that could hurt overseas businesses is one major wild
card, as is the long-term potential effect of funding more
"comparative effectiveness" studies, which the White House has
backed as a method of picking top treatments while saving
money.
Many device companies' revenue growth depends in part on
so-called mix upgrades that come from issuing newer devices that
fetch premium prices based on expectations for patient benefits.
But what if future research indicates souped-up models don't
deliver benefits that justify their higher costs?
"In my view, that's arguably the most damaging for a business
model long-term," Loucks said.
Heart-devices companies may have some shielding against this,
because their products generally require substantial clinical
evidence to win approval, giving the companies ammunition with
which to prove their value. Major orthopedic devices, on the other
hand, have long been approved through a less stringent system that
doesn't require the same level of evidence.
Pressure on product prices - as the government looks to restrain
spending - is also a threat, although an uncertain one. The
government has little direct control but can indirectly influence
prices by how it reimburses hospitals.
There is worry that a squeeze on payments to hospitals will lead
hospitals to look for savings on product prices, and many top
medical devices are geared toward older patients who are covered by
the government-run Medicare system.
William A. Hawkins, Medtronic's chief executive, recently
highlighted the broad issues that will determine how health reform
affects device companies.
While covering millions of currently uninsured Americans "could
be very good for us," he said during an investor and analyst
conference, "the clear focus on cost containment could undoubtedly
put pressure on the entire medtech industry."
-By Jon Kamp, Dow Jones Newswires; 617-654-6728;
jon.kamp@dowjones.com