Although there are still plenty of major healthcare companies left to report first quarter earnings, the early returns are not too positive on the sector. The themes that dominated last year, weak procedural volume and relentless pressure on pricing and reimbursement, seem very much in play. That makes margin leverage and a healthy product launch portfolio even more important in the short term.
Surgery Is Looking Soft
Covidien (NYSE:COV) and Stryker (NYSE:SYK) have yet to report as of this writing, but the data so far suggests that the surgery market is still pretty sluggish. Johnson & Johnson (NYSE:JNJ) reported that revenue in its surgical business was down more than 5%, while the specialty surgery business was up just 1% in constant currency.
Johnson & Johnson management intimated that competition played at least some role in those results, and certainly Intuitive Surgical (NSDQ:ISRG) saw better growth. Procedure volume at Intuitve was up 18% as reported and 20% on an adjusted basis, but it’s worth noting that those figures were likewise below sell-side expectations for the quarter.
Mixed Messages In Orthopedics
Orthopedics has long been a major market in search of recovery, and here too the data is mixed early in the reporting cycle. Biomet did report that hip and knee implant sales improved 4% on an adjusted basis, while extremities were up 21%. On a less positive note, spine sales were up just 2% and reversed what had been a decent trend.
Results were weaker at Johnson & Johnson. Overall orthopedic sales were basically flat on an organic basis, with all of the growth coming from the Synthes deal. JNJ’s spine business was even softer than Biomet (down 7%), and hips and knees were weaker as well (up 2% and down 1%, respectively) though hips were closer to sell-side expectations.
With these results in tow, it’s hard to feel especially confident about the upcoming reports from Stryker, Zimmer (NYSE:ZMH), and Smith & Nephew (FTSE:SN, NYSE:SNN), as they have all generally been lagging the market in recent quarter. It does look, though, like companies with solid exposure to extremities or trauma could fare relatively better.
CRM Still Beating Weakly
Only 1 of the 3 major cardiac rhythm management companies has reported thus far, and St. Jude Medical (NYSE:STJ) report was not all that encouraging. Pacemaker sales were down 11% for the first quarter, while ICD sales dropped 4%. While these results were a little weak, St. Jude has at least held up better than the bears have expected given the controversy over the company’s leads. At this point, then, it looks like Medtronic (NYSE:MDT) may be poised to continue gaining share, while the weak results at St. Jude likely do not bode well for Boston Scientific (NYSE:BSX).
Reimbursement Has Sapped Diabetes
One of the notably weak sectors of the med-tech industry is the diabetes care sector. Johnson & Johnson and Roche (PINK:RHHBY) both reported significant year-on-year declines in revenue from their businesses (down 10% and 5%, respectively), while Abbott (NYSE:ABT) saw reported sales down almost 1% and operational sales basically flat.
The story here is pricing pressure and reimbursement cuts. Though there have been numerous articles and columns discussing the growing global epidemic of diabetes, not as much attention has been paid to the sometimes severe reimbursement adjustments that have come as a result. Not only are companies having to compete harder on price, but many insurance and health care systems are cutting back on the amount of testing they reimburse for (the number of strips per day, etc.).
The Bottom Line
So far, it’s looking like the healthcare sector may be hard-pressed to continue delivering double-digit capital gains on the basis of this sort of earnings momentum. Companies with new products in new markets, a list that would include companies like Edwards Lifesciences (NYSE:EW) and HeartWare International (NSDQ:HTWR), are doing reasonably well, but growth in well-established markets is proving to be much harder to come by.
As a result, clinical, regulatory, and reimbursement success in products like transcatheter heart valves, renal denervation, atrial fibrillation is going to be even more critical to the sector. Likewise, I would look for the market to start putting a premium on those companies with the ability to grow their overseas sales (particularly in emerging markets like China) and improve their margins. That could play well for companies like Medtronic and Stryker in the near term.
At the bottom line, though, investors should be wary of this sector. Stocks like Medtronic, Covidien, and Stryker do still seem to offer investors some relative bargains, but the sector-wide move up may stall out if revenue does not improve as the year goes on.
Disclosure: The author owns shares of Roche.
Stephen Simpson CFA is a former sell-side and buy-side analyst who focuses most of his professional attention on financial and investment writing. In addition to a decade of work as an analyst, Mr. Simpson has worked as a wet-bench biomedical researcher and a consultant in the med-tech industry, as well as writing on a freelance basis for over 10 years. He can be reached via email at firstname.lastname@example.org.