Superficially, the healthcare sector in Europe looks attractively valued relative to consumer staples, but on a cashflow basis the relative valuation argument disappears. This may reflect more aggressive earnings adjustments in European healthcare.
In the US though, the valuation gap between healthcare and consumer staples does look more real and may reflect nervousness around the potential for healthcare reform post the upcoming US Presidential election. As we move closer to the election itself, rhetoric around drug pricing may increase again and it remains to be seen whether fear of further US drug pricing pressure outweighs the ongoing concerns about the global impact of the Brexit vote.
The charts tell the story
European consumer staples companies are trading at a 30% P/E premium to European healthcare, the biggest gap between the two sectors since 2012 . . . . .
. . . . but unlike in 2012, the valuation gap disappears when you compare free cashflow yields.
Does this reflect the fact that the gap between reported and adjusted earnings is larger in healthcare? (We blogged on GAAP vs non GAAP in January).
Looking at the US, the relative valuation is as compelling as it has been at any time in the last five years . . .
. . .while less compelling on a relative free cashflow yield basis.
There is a real argument in favour of US healthcare compared to US consumer staples however, the upcoming US Presidential election and fears of subsequent healthcare reform may in part be responsible.
Since 24 June when the UK electorate voted in favour of leaving the EU, both consumer staples and healthcare have outperformed the broader US and EU markets (as we highlighted in our blog on the UK). This is understandable given both sectors are defensive in a less certain post-Brexit world and offer sustainable dividend yields that appear increasingly attractive in a market where such characteristics are becoming harder to find.
However, with political rhetoric around US drug pricing regulation likely to grow again ahead of the election – for example, Clinton’s Healthcare Plan announced last weekend makes explicit reference to allowing Medicare (which provides healthcare for the over 65s) to negotiate drug prices directly – it remains to be seen whether the Brexit impact or US drug pricing fears will hold sway with investors.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.