While the final three months of 2018 wiped out much of the gains created in the overall market in the first three quarters of the year, the average large cap medtech stock outperformed the S&P 500 for the fifth consecutive year. According to Bank of America Merrill Lynch, large cap medtech started 2018 at a 3% premium to the S&P 500 and now trades at a 23% premium to the S&P 500 on one year forward P/E, which is within a few points of the ten-year relative high. With uncertainty in the direction of the overall market and the relative valuation premium of the large-cap medtech being close to the 25% level set ten years ago, 2019 looks to be a very interesting year for medtech investors.
Corporate Fundamentals
Over the past several years, corporate fundamentals for the average medtech company have increased on an annual basis. According to Morgan Stanley research, 2018 organic growth for its medtech coverage was approximately 6.0%, a 100+ bps improvement over 2017 levels. This revenue growth was driven by new product innovations, robust emerging market growth rates, better than expected hospital volumes, and slightly positive insurance reimbursement rates.
Looking to 2019, revenue growth should continue at a similar pace to 2018, but might not outperform 2018 levels. Looking at the pace of FDA approvals and clearances for 2018, there were 26 non-supplemental PMA approvals in 2018, which was down from 46 in 2017. The number of traditional 510k clearances were also down year over year, to 2,541 in 2018 from 2,621 in 2017. While not all PMAs and 510ks are created equal, the year over year decrease in approvals and clearances could hinder 2019 revenue growth. On the flipside, there are many exciting technologies currently in pivotal clinical trials which could drive growth for the foreseeable future.
Emerging markets have played a large role in the overall revenue growth for the large cap medtech companies over the past few years. According to Bank of America Merrill Lynch, emerging markets drove 20-25% of total large cap medtech growth in 2018. During the summer and also in September, China imposed tariffs on $4.7 billion in US medtech exports, with the majority occurring in September. If these tariffs continue throughout 2019, they could negatively impact medtech growth rates.
Hospital procedure volumes have not had an impact on medtech growth for the past several years. In 2019, the potential migration of certain procedures to ambulatory surgery centers (ASC) from hospitals could dampen medtech growth, as reimbursement rates for ASCs are typically lower than hospital-based procedures.
Medicare and private insurance reimbursement rates have been a slight positive for the medtech sector over the several few years, as many policymakers have focused most of their attention to the pricing of certain biotech and pharmaceutical therapies. This is expected to continue, but the movement towards value-based care may negatively impact reimbursement rates.
Washington DC
Medicare and private insurance reimbursement rates have been a slight positive for the medtech sector over the several few years, as many policymakers have focused most of their attention to the pricing of certain biotech and pharmaceutical therapies. This is expected to continue, but the movement towards value-based care may negatively impact reimbursement rates.
Downtrodden Sectors
Over the past three months, the overall valuations of the biotech and pharma sectors have been decimated. With medtech stocks faring better in 2018, capital could move out of medtech into other healthcare sectors.
Overall, medtech is poised to have a solid 2019, as strong fundamentals should drive stock prices. That being said, stock picking could play a larger role compared to 2018, as overall valuations should remain constant. 2019 could turn out to be a “Missouri” year, where investors will demand companies “show me” strong fundamentals prior to investing capital. For more thoughts on 2019 and beyond, contact us.
Greg Chodaczek, Managing Director
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