As the dust settles after another earnings season, it’s time to look back at what we now know about the state of the industry. Stocks in the sector have been enjoying a run that started in November 2012 on hopes for improving utilization trends and earnings in 2013.
While the results and guidance from this latest round of earnings suggest that expectations around utilization may have been a bit too optimistic, it does look like the industry is on firmer footing than a year ago.
Ortho leads the way
The orthopedics market never really went away, but the scant volume growth of 2011 (roughly 1%) and weak pricing served as a wake-up call that ortho is no longer a business in which companies or analysts can assume low-to-mid single-digit growth indefinitely. While 2012 seemed to get worse on a quarter-by-quarter basis, the industry ended 2012 on a strong note.
Pricing pressure was still an issue for the industry in the 4th quarter, as recon pricing seems to have fallen about 2% across the sector. Volume growth rebounded back above 3%, however, and the companies seem confident that they are back on more sustainable growth footing.
That said, this is a highly competitive industry, meaning smaller players like Smith & Nephew (FTSE:SN, NYSE:SNN) and Wright Medical (NSDQ:WMGI) run the risk of slipping below the point of critical mass at which they can really be sustained players in the global hip and knee markets. That could be particularly relevant as companies like Johnson & Johnson (NYSE:JNJ) and Stryker (NYSE:SYK) focus on counterbalancing pricing pressures and the new device excise tax with leaner manufacturing and more cost-efficient sourcing and distribution.
It’s not just the large, core recon market that’s improving. Although the spine market was down for 2012 and share leader Medtronic (NYSE:MDT) continues to struggle, other players like JNJ and Stryker have seemed incrementally more positive. Likewise for the extremities market, with companies looking for new product launches to help offset some of the pricing pushback from hospitals.
Cardio getting better? Maybe…
Calendar 4th-quarter earnings didn’t speak as strongly to improvements in the cardiology market. Medtronic, Boston Scientific (NYSE:BSX) and St. Jude Medical (NYSE:STJ) all had relatively underwhelming reports when it came to ICD and pacemaker revenues, with the industry as a whole down about 3%. Both St. Jude and Boston Scientific were unwilling donors of market share to Medtronic, but all 3 told fairly optimistic tales of market stabilization.
On the stent side of things, the best that can really be said is that the 4th quarter was the least-bad quarter we’ve seen in a while. Medtronic was the only grower, helped to an enormous degree by its newest product launch, and it doesn’t sound as though any of the major players are banking on a big improvement in underlying market conditions for 2013.
Capex spending – the money is there, but where will it go?
One of the more interesting takeaways from the earnings cycle was the commentary from hospital capital-equipment providers. Broadly speaking, it looks like the money is there in the hospital budgets, but the priorities for that spending could make for some interesting dichotomies as the year rolls on.
Growth for basic equipment like hospital beds is going to be pretty hard to come by, judging by the commentary from Stryker and Hill-Rom Holdings (NYSE:HRC). Likewise, it sounds like the radiation oncology and imaging equipment sold by the likes of Varian Medical (NYSE:VAR) and Hologic (NSDQ:HOLX) is lower on the list of priorities, at least in North America.
On the other hand, it doesn’t sound as though Intuitive Surgical (NSDQ:ISRG) is having nearly the same difficulties in generating interest in its surgical robots (even notwithstanding papers questioning the economic utility of robot-assisted surgery). Likewise, it looks as though diagnostics demand will be solid for players like General Electric (NYSE:GE). The biggest winners of all, though, may not even be device companies – spending on hospital IT systems seems to be 1 of the biggest priorities this year, but I’d remind readers that there have been many "false dawns" before in healthcare IT in which the spending realities didn’t match up with earlier indications, guidance and surveys.
A confidence game
As a parting thought, it’s worth noting that the economic health of the consumer plays a bigger role in healthcare than commonly acknowledged. While it’s true that you can’t schedule a heart attack or broken arm, the post-housing bubble recession/malaise has shown that healthcare spending is more economically sensitive than previously believed. In fact, since the bubble burst, physician visits and hospital admissions have tracked relatively closely with consumer confidence.
With the new 2.3% medical device excise tax leading companies to try to pass on that cost to hospitals and patients, and changes to payroll taxes and many corporate insurance plans taking more money out of wallets, there could be some headwinds for healthcare in 2013 – particularly as the big surge in insured patients is still a ways off.
The bottom line
Medtech stocks have enjoyed a good run. In fact, they’re now trading at a slight premium to the market as a whole (which has historically been the norm). While the strength in orthopedics-oriented names and the relative weakness in capex-oriented names each make sense, expectations are rising on Wall Street. With overall procedure volumes still soft, companies are going to have to deliver solid internal margin improvements to keep up the momentum in 2013.
Stephen Simpson, CFA, is a freelance financial writer, investor, and consultant. More of Mr. Simpson’s writings can be found at his blog Kratisto Investing
