How Inflation is Hitting the Health-Care Sector

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Michal Marszal, CFA

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My name is Michal Marszal. I’m a portfolio manager focusing on the global healthcare sector at CIBC Asset Management.

Investors typically have a perception of the global healthcare sector as being immune from macroeconomic headwinds and mostly focus on other risk factors that are more specific to the sector, such as regulatory reforms, changes with respect to the economics of different healthcare systems, which are mostly political factors that are very specific to a given geography.

That of course doesn’t apply across the entire healthcare sector. There are pockets of cyclical exposure within this space, but these are mostly relatively limited. We typically think of cyclical exposures within healthcare and the context of talking about certain medical devices over life science tools. Companies that provide instrumentation to various companies within the global industrials or global energy sectors.

Today’s conditions are a little bit more complex and somewhat unusual. We do have, of course, a very significant shift in the inflationary pressure. And that is typically not something that has been discussed widely within the global healthcare sector, but today, given the magnitude of inflationary impact on the global economy, we do have to focus on that. And be mindful of the fact that impact is going to be very, very different depending on which sub-sector of healthcare we’re talking about.

So in the broader biopharmaceutical space, that impact is relatively low. Now we are not dealing with significant issues as they pertain to the cost of manufacturing the majority of biopharmaceuticals, which are typically extremely high margin products, perhaps with the exception of certain generics. And these companies are relatively good at passing on pricing to the end consumer, which are typically government-subsidized healthcare systems or somewhat privatized healthcare systems. Because for the most part these companies are in relatively oligopolistic or monopolistic positions with respect to their therapeutic categories and individual assets inside of those categories.

However, there is a significantly higher impact of inflationary pressures within the device sector, as well as the services sector for two very different reasons. Within medical devices and technologies, we are mostly focusing on the impact on the cost of goods. Higher input into manufacturing of medical technologies will then translate into lower growth margins. And these companies do have a limited ability to pass those prices on to their customers.

Within the services sector, we are dealing with a tighter labour market. Higher cost for providers, lab for the human capital that is employed inside of these organizations, which is relatively specifically trained and therefore relatively inelastic with respect to tapping into any over or under-supply of that human capital, obviously creates a significant pressure with respect to wages that are impacting the sales and general expenses of these companies.

I would also say that inflation is one element here that, of course, has been significantly impacted by supply shortages. And the shortages themselves, outside of the fact that they are resulting in higher prices, input costs, they also, they themselves have a significant impact on the sales cycle. And again, this is now specifically having a disproportionate impact on the medical technology sector. So sort of a double whammy: it’s higher input cost affecting growth margins, but also supply shortages that are delaying placement of certain tools and medical devices inside of labs, inside of hospitals, and so on.

So these are mostly the CapEx exposed companies that are now dealing with shortages of semiconductors and other critical input components, such that they can take orders in, but they simply cannot fulfill them as they used to. And we don’t really see yet a very clear path toward resolution of these issues for that specific sub-sector within healthcare.

The last thing I would mention is that all of this is happening in the context of the broader re-equilibration of a probably most important relationship when it comes to the global economy and the global technology sector, and somewhat that related to the global healthcare sector. Which is the US-China trade and security relationship where we are seeing a greater focus on technology transferred restrictions. We’ve seen in healthcare, for example, a very notable example of that with a company called WuXi Biologics most recently, a very important contract manufacturing global player.

As a result of that, coming from the other side, we are seeing an increasing market access issue for many multinational companies that are trying to tap into the growth within the global healthcare sector that is offered by the Chinese market. So those two factors are having that secondary impact with respect to the growth outlook for certain pockets of healthcare.