Health Care: Strong Fundamentals and Attractive Valuation Amid Uncertainty

Health Care: Strong Fundamentals and Attractive Valuation Amid Uncertainty

Health Care is an attractive sector, with immutable drivers of growth, including aging demographics, rising demand from emerging markets, and most importantly, innovation with barriers to entry.  

The most distinguishing characteristic of the sector versus other growth sectors is its resilience and reliability, as demand is less correlated to the economy. The resulting lower volatility in earnings means the sector tends to outperform in periods of overall market underperformance, a trait we deem important.  

On the other hand, Health Care as a sector does tend to lag in ebullient markets, and sometimes, during U.S. elections. Regulation is part of the reason why many companies can enjoy high barriers to entry and high pricing power, so uncertainties introduced during elections can make investors anxious about potential regulatory changes. This was the background for much of the underperformance in the fourth quarter of 2024 as general apprehension prevailed.  Even though healthcare is not a high priority for the new Trump administration, the nomination of RFK Jr. as Secretary of Health and Human Services (HHS) sent ripples through the industry due to his well-known anti-corporate stance: he has professed beliefs that companies profit from promoting illness, while colluding with corrupt government agencies. 

Peering through what RFK Jr has said, we think the following are possible:   

▪ Stricter oversight of the food industry and ultra processed foods, including a banning of food ingredients that have not been approved in Europe (with the caveat that he faces political conflicts with the agriculture industry on some issues)  

▪ Casting doubt in parents’ minds regarding paediatric vaccines by speaking publicly as an authoritative figure; reducing federal funding for paediatric vaccines  

▪ Partial changes to members of ACIP (Advisory Committee on Immunization Practices), which could make vaccine recommendations marginally more difficult in the future   

▪ Altered FDA advisory boards and regulatory guidance documents over time, which could make drug/vaccine approvals more costly or difficult   

▪ Increased restrictions on pharmaceutical advertising, although bans would be difficult due to First Amendment  

conflicts  

▪ Potentially more aggressive drug pricing negotiations for Medicare  

▪ Reduced NIH funding, in cooperation with a Republican Congress  

▪ Inducement of key personnel resignations throughout related agencies  

Presently, we are not concerned with impact to our portfolio companies, as they do not have meaningful exposure to the primary areas of concern, vaccines and food. However, we will watch closely for actual policy announcements.  We note also that there would be important limitations to RFK Jr.’s authority. He cannot unilaterally withdraw existing drug approvals or approved vaccines and must work through established agency processes (which include industry input in some cases) and Congressional mandates. We also have found over the years that many companies manage to adapt to new policies.  

Beyond policy uncertainty in the U.S., the long-term fundamentals of the broader Health Care landscape remain strong. The sector maintains its resilient characteristics, and its long-term growth drivers remain intact. The World Health Organization projects that the global population over 60 will nearly double to 22% by 2050. According to the Kaiser Family Foundation, people over 55 currently account for 55% of total health spending while representing a minority of the population. This aging demographic trend, combined with rising global wealth and an expanding middle class, continues to drive secular growth for healthcare.  

Additionally, innovation in the sector is accelerating. Novel drug launches in the past four years have increased 47% compared to the previous four-year period. Breakthrough medical device designations have more than doubled in the same timeframe. These innovations target age-related chronic conditions like cancer, cardiovascular disease/obesity, Alzheimer's, and vision problems, representing significant growth opportunities for many of our portfolio companies.  

Analyses of Company Opportunities/Risk  

Recent sector turbulence has had notable impacts on several key healthcare companies’ returns, magnifying negative reactions. We think this has created an opportunity for attractive returns over the medium- and long-term. UnitedHealth in particular has faced significant pressures following rising medical costs and the tragic murder of UnitedHealthcare CEO Brian Thompson, which sparked some social media backlash against insurance practices.  

Outside of some policy uncertainty, UnitedHealth's long term fundamental position is robust. While the company has recently experienced a more pronounced increase in medical costs, it regularly adjusts pricing based on actuarial analysis of medical cost trends, suggesting current cost pressures are likely transitory. Independent surveys paint a more positive picture of health insurance satisfaction than social media might suggest, as the Kaiser Family Foundation, American Customer Satisfaction Index, and AHIP surveys all indicate satisfaction rates above 75%. This is not to say there aren’t problems in the current U.S. healthcare system (there are lots, one of which is the fact that those with rich employer sponsored health insurance do not want to give it up), but the reality is that it is UnitedHealth’s job to “manage” insatiable health care demand in a resource-constrained world. The company remains key to addressing the rising healthcare costs in the U.S. given its leadership in outcomes data and its large network of efficient care facilities and is well positioned to deliver double-digit earnings-per-share growth into the future following a modest slowdown in 2025.  

Life science tools and CRO (contract research organization) companies like ICON have experienced earnings pressure in the past two years as their pharma and biotech customers have reigned in spending after aggressively overspending during the pandemic.  Customers have also been reprioritizing their research and development pipelines to better align to the incentives of the Inflation Reduction Act law. Covid vaccines/testing falloff as well as customer inventory destocking have also posed headwinds. While the general uncertainty and potential FDA changes could cause short-term disruption, the underlying demand for new drug development remains strong. Industry metrics including funding levels, drug launches, and R&D success rates indicate continued robust investment in research programs. ICON, with its deeply embedded products and services in customer workflows, should continue benefiting from increasing drug development activity as well as continued growth in the manufacturing of biologic drugs.  

The primary policy uncertainty for Novo Nordisk is Medicare drug price negotiations for semaglutide (Ozempic and Wegovy), expected in 2027. There is some possibility that this gets delayed, as there is a bipartisan bill to reduce the ”pill penalty”: Medicare drug price negotiation starts at 9 years for smaller molecules (including semaglutide) versus 13 years for larger molecules, which creates odd incentives as generally, smaller molecules are less expensive to the system. Either way, we believe this is manageable, although 2027 earnings growth is expected to be below trend. Separately, Novo received mixed clinical trial results for their latest obesity drug CagriSema in the fourth quarter of 2024, as the weight loss of 20.8% over 68 weeks was below the targeted 25%. Some of this shortfall may be explained by the design of the clinical trial which did not force patients (obese and overweight) to go onto the highest dose of CagriSema, which resulted in a very low drop out rate. For those that titrated up to the highest dose, the weight loss was 22.7% which was better but still below the 25% goal. The good news is that the drug is safe and has higher efficacy than its currently marketed drug Wegovy. While the results were disappointing given expectations, these results still represent an advancement in obesity treatment (40% of patients achieving 25%+ weight loss!) and we expect Novo to continue to innovate following CagriSema. The advancement of GLP-1 drugs has great potential to address other major chronic disease states like cardiovascular/renal diseases and addiction, and we expect the company can continue to deliver resilient and compounding cash flows, as it has demonstrated over multiple decades.  

Summary  

The Health Care sector is experiencing short-term uncertainty driven by political factors, particularly the potential appointment of RFK Jr. as HHS Secretary. However, long-term fundamentals remain strong, supported by:  

▪ Demographic trends driving increased healthcare demand  

▪ Continuous innovation in drugs and medical devices  

▪ Resilient sector characteristics independent of economic cycles  

In addition, we have selected companies with durable business models that take advantage of secular demands within the sector, and we are enthusiastic about the opportunity from here and recently added to many of the positions.