Don’t be fooled by the value trap in healthcare

The demand for gloves could stay at a high level due to the growing awareness among the public in the wake of the pandemic


WHILE many had been expecting the public health crisis to come to an end this year, the resurgence of Covid-19 Delta variant cases has put the global reopening in jeopardy and clouded the economic recovery prospects in the second half of 2021.

Thus, the healthcare theme has once again made headlines after the pullback in the healthcare sector.

After such a massive correction, is the healthcare sector worth taking a look now?

Malaysia’s healthcare sector can be further segmented into two main subsegments — healthcare equipment and services companies (ie glovemakers) and healthcare providers (ie hospital operators) which contribute 54.35% and 41.84% respectively to the Bursa Health Care Index respectively.

Each has its unique drivers which would require different analyses.

Firstly, there could be more potential downside for glovemakers to come as the demand-supply gap is expected to narrow and weigh on average selling prices (ASPs) and margins.

The demand for gloves for the next one to two years is expected to remain high with the backdrop of the virus’ resurgence and detection of new variants across the globe.

Once the vaccination rates ramped up and more countries achieve herd immunity against the virus, global glove demand is expected to taper but continue to stay above the global demand level prior to the Covid-19 outbreak.

Beyond the Covid-19 pandemic, the demand for gloves could stay at a high level due to the growing awareness among the public in the wake of the pandemic.

The increased healthcare standards in emerging economies, growing government expenditure on healthcare reform, increasing awareness of health-related issues and an ageing population in the developed and emerging economies will continue to drive the industry’s expansion.

Supply, however, is expected to increase in the coming years as glovemakers aggressively increase production capacity.

The temporary situation where demand outstrips supply is expected to underpin the glove company performances until at least this year.

The five biggest global glovemakers (Top Glove Corp Bhd, Hartalega Holdings Bhd, Supermax Corp Bhd, Kossan Rubber Industries Bhd and Sri Trang Gloves Thailand) have been aggressively ramping up their production capacity since the outbreak of Covid-19 pandemic in order to cater to the greater demand across the globe.

Based on projections, these companies are planning to increase total production from 231 billion pieces per annum in 2020 to 463.5 billion pieces per annum in 2024.

This figure has not taken into account the production increases of smaller players.

Furthermore, the competition in the glove sector has intensified as more non-traditional glove companies have ventured into glove production to ride on this secular trend, adding further supply to the market.

As a result, we think it will eventually lead to downward pressure on the ASP of gloves and, hence, the margins and profits of glove companies down the road.

As for healthcare providers, we remain neutral on their prospects as valuations have priced in future prospects and rebound in patient volume.

The outbreak of Covid-19 has presented unprecedented challenges to the global economy, across all industries, including the healthcare providers.

Patient volumes have come in at a softer reading compared to the period before the virus outbreak, mainly attributed to the postponement of non-urgent treatment and visits to hospitals and healthcare facilities.

However, the fall in revenues of the healthcare provider industry was cushioned partly by the contributions from Covid-19 related services rendered.

Prospects for healthcare providers are expected to remain resilient in the near term, supported by their active collaboration with the public healthcare sector to provide Covid19 screening services, laboratory testing and assist governments in administering Covid-19 vaccines.

Beyond the pandemic, patients who intentionally delayed in seeking treatment at hospitals previously due to the fear of Covid-19 infection will likely return to receive treatment and thus recoup the pandemic-induced losses.

The conclusion is, don’t be fooled by the value trap in the healthcare sector.

While the Bursa Healthcare Index has retraced from its peak and the healthcare sector is trading at a price to earnings ratio (PER) of of 6.70X for 2021, PER 2022 of 14.62X and PER 2023 of 19.33X, which seemingly presents an opportunity for investors to capitalise on the exposure in healthcare companies on the cheap, it could be a value trap.

Investors should not be fooled by the value trap in the Malaysian healthcare sector as the cheaper valuation is mainly attributed to the supernormal earnings during the pandemic.

Going forward, in a post-pandemic world, we foresee the tapering of global demand for gloves and given the massive increases in production capacity, supply would outstrip demand over the next few years.

Subsequently, this would weigh down the glove ASP and margins for glovemakers and result in a normalisation of profits.

On the other hand, the recovery in healthcare services providers may not be enough to cushion the drop in earnings for the glovemakers.

With that, we expect negative earnings growth of -54.1% and -24.4% for the financial year 2022 (FY22) and FY23 respectively for the healthcare sector.

Negative earnings growth could possibly continue to weigh on the market sentiment and inflict more pain to the healthcare sector.

The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s owners and editorial board.