BB Healthcare (BBH) has been actively growing over the past year, with issued shares increasing by 36% over the financial year to 30 November 2019. We covered its annual results last month, which you can access by clicking here. The environment has obviously changed beyond recognition since we last wrote on BBH, with Covid-19 developing into a global pandemic.
BBH’s managers, Paul Major and Brett Darke, published a comprehensive update earlier today. We are providing a text extract copy for you – to access the complete PDF version, click on this link.
‘Facts are your friend, fear is your enemy’
“Most of the content of the January and February factsheets has been devoted to the ongoing Covid-19 outbreak. That early reads on its biological properties have played out largely as anticipated is of no comfort, nor has it helped overmuch with respect to our navigation of the market reaction to it, which has been devastating and, in some ways, abstruse. It is vitally important that we all remember this disease has a limited impact on the vast majority of people, who will experience only mildly debilitating symptoms and will then recover without long-term health consequences. It appears more lethal than seasonal flu, but we would argue it is currently impossible to say with any confidence how much worse it is due to the patchy nature of testing. A fraction without a correct denominator is just a random number…
You are all probably fed up of charts, particularly the ones in newspapers that extrapolate early trends far into the future to generate massive numbers of mortality and hospitalisations. Scenario planning is well and good, but we struggle to see an obvious path to claims like eight million UK hospitalisations and hundreds of thousands of deaths, as some media outlets have chosen to focus on. These really are worst possible world extrapolations and, in our opinion, the outbreaks in Spain and France for example are tracking at the lower end of scenario models that we have seen. As a tonic to sensationalism, we offer another chart from the WHO (click on this link to access BBH’s report in PDF form), which shows a consistent pattern of infection tapering 2-3 months into an outbreak. It is worth pointing out that Hong Kong and Japan have not imposed draconian measures on the populace, but rather people have themselves taken precautions to stem the spread, as people and companies are now doing here in the UK. In all cases though, extrapolation of early trends is probably unwarranted. Italy does stand out as “Wuhan-like” to some extent, but we shall return to that topic later.”
‘What has happened?’
“Paranoia and panic are sound evolutionary strategies to avoid death in the unfriendly world humanity was born into. In today’s safe and highly connected world though, they become the driver of the self-fulfilling prophecy. It does not really matter anymore what the course of this pandemic looks like; consumer behaviour (either voluntarily or by government edict) has changed and the economic carnage that will follow may prove short-lived, but it will feel very real to those who are impacted. Make no mistake; that impact is profound and we are already seeing it play out here in the UK, with two high street names now having closed their doors and many of the small businesses local to us struggling.
The scale of the economic challenge is significant. For instance, we can all envisage layoffs in the tourism sector as hotels, bars, restaurants, airlines, cruise lines etc. adjust to lower volumes when their costs are painfully fixed. This notion is thrown into starker relief though when one considers that the tourism industry directly employs >300 million people globally. A 10% cut in employment is thus equivalent to making the entire population of Malaysia unemployed. In turn, these people cannot spend as before and so the economic contagion spreads even faster than the virus causing it.
How has the market reacted? The halcyon days of new year optimism saw the MSCI world healthcare index rise >5% in the year to 12th February. It then retreated ~1%, only to recover its peak by 19th February, despite the burgeoning headlines around the virus, which was declared a global emergency by the WHO on 30th January.
And then the sell-off began, as the epidemic took hold in Korea and Iran. Why was this the trigger, when so much had already happened over the prior three weeks? We will never really know, but the Korean and Iranian outbreaks were the first where there was not a clear person-to-person link back to China and the original outbreak in Hubei. Considering facts such as those above, a material market correction from levels where economic growth is robust and employment generally full seems a reasonable response. But how much is ‘enough’?
As ever in these situations, the jolt downward has been interspersed with short-lived and sometimes violent recoveries (the perished cat carom). As of 19th March, the MSCI world healthcare index has declined 12.1% from its peak. The healthcare sector has exhibited defensive characteristics; its 7.3% year-to date fall contrasts with a 17.5% decline for the parent MSCI World Index.
As noted above, the wider market sell-off has gathered pace as investors became concerned and frustrated at the lack of synchronous government action to mitigate firstly the infection’s spread and impact and secondly the inevitable economic fallout arising from changes in consumer behaviour (and government edicts). Let us leave the market to one side for a moment, and return to the epidemiology. We reiterate our view that all the current data about the prevalence of the virus and the incidence of severe clinical effects needs to be interpreted with caution; there will be a direct correlation with the amount of testing being carried out and the apparent speed and extent of spread. Under-testing makes the spread look “peakier” and the severity worse; it hits like a tsunami because the earlier mild cases are effectively not recognised as such.
For example, one town in Italy (called Vo) tested its entire population in late February and found a 3% positivity rate, with 50% of the positives being asymptomatic. This is a possibly unique and interesting dataset. Across Italy, non-random testing positivity has been >4%, so we can probably conclude Vo’s 3% is a reasonable proxy for the prevalence of the disease. This would imply there are >2.5 million cases in the country as a whole. When seen in this context, its 3,500-odd deaths are more comprehensible. We will return to the mortality data below.
Fear is peaking, what might make it begin to subside? It is probably only evidence of declining new cases. On a less positive note, we would argue that declining new case reports is not prima facie evidence of containment or peak prevalence given the limitations of testing (which become greater as the number infected climbs); the best proxy we will have for now regarding impact is hospitalisation data and even there, the worst-hit regions will be struggling to admit all the needy patients. We also urge caution on the apparent wonder of containment by edict; it will curtail spread but the infection can recur if there is a ready reservoir of the unexposed to infect once restrictions are lifted. This will be another tricky journey for societies to manage, and one for which there is no historical precedence to guide us.
The most commonly asked question from investors in recent days has been why Italy of all places (renowned for the quality of its healthcare outcomes in a European context) is seemingly suffering so much, in terms of the rapidity of spread and severity of outcomes (mortality etc.). We remain of the view that this is an artefact born of slow testing in the early phase, compounded with multiple socio-cultural factors. Italy is a very sociable place, with lots of close contact (cheek kissing etc.) in normal life and a lot of elderly people (second only to Japan), with many living closely to younger relatives who, per the Vo data, might not even realise that they are infected.
As we went to press, there are now ~41,000 live cases in Italy and ~7,850 closed cases. 43% of these have ended in deaths. Open cases is now ~33,000 and 92% of these are considered to be mild. For Spain, its 94% and 43% for closed cases that ended in death. When these resolve, things should begin to look different. For Spain, another socio-culturally similar country, 94% of open cases are deemed mild and 33% of closed cases ended in death. It remains the case globally that mortality in the 0-50 age group is around 0.2%, but again this will be impacted by the testing rate in each country.
The demographics of the mortality in Italy are also interesting (per the Lancet paper from 13th March), with a median age of 79 for men and 83 for women, 2/3 with pre-existing conditions and 74% over the age of 70 and 83% over 60. The under 50s have made up only 3% of deaths but account for ~65% of the population. This latter point is simply not correlative with the levels of anxiety being expressed by the general public about their own personal risk and that of their families (particularly children) and we hope that it will put some of our reader’s minds at rest as well. We are not saying this disease poses no risk to younger people, nor seeking to trivialise its impact on those impacted. We are merely trying to emphasise that the data has consistently shown that the probability of a young, healthy person (i.e. the vast majority of humanity) suffering adversely is very low. It is vital to keep this in mind. Nonetheless, this anxiety and the behaviour changes in response to it, lead the managers to believe that a global recession is likely inevitable.
We would also reiterate our view that healthcare stands apart from the wider economy. If there is a global downturn, it will have little impact on the industry’s demand side as a whole, although the close correlation in the all important US market between having a job and having access to medical insurance that adequately covers medical treatment for non-life threatening conditions should not be ignored in the event of a material increase in unemployment. In that sense then, healthcare’s defensive attributes in these sorts of market sell-offs are well deserved.”
‘The anatomy of panic’
“It is a truism that the market is not an efficient aggregator of data in the short term. Within the market, various structural trends (passive strategies, ETFs, algorithmic trading) are widely believed to have exacerbated volatility in recent years, particularly during times of market stress. As such, it is not reasonable to think that short-term share price reactions in times like these will be rational; the two phases of a crash are “sell what you can”, followed by “sell everything”.
It increasingly feels that we have entered this second (and final) phase. Unfortunately, history tells us there is no easy way to accurately call the bottom. We are all acutely aware how painful this can be to one’s wallet and for some people, the consequences to their very livelihoods will be profound.
On the other hand though, volatility also creates opportunity and there will be many a baby thrown out with the bathwater. If we think about the past few weeks and empirical observations of other economic shocks, there are a number of qualitative conclusions one might reasonably draw about the market’s behaviour within the healthcare sphere:
- Managed care should do well: Bernie Sanders primary campaign is on the ropes and, whilst US hospitals may fill with elderly patients suffering pneumonia, elective procedures will be postponed and these are costs that the insurance company would be on the hook for. Medical costs for treating patients may thus improve through Q1/Q2, especially for those insurers less exposed to the elderly Medicare population. The opposite is true for hospitals (Facilities); the profits are made in caring for the mildly unwell via elective procedures. Margins are thin and capex and debt levels generally high, so profits will be hit hard. Maybe the US government will help though.
- Pharma, Spec Pharma and Biotech should be a safe place to hide: prescriptions are generally necessary and people are no more likely to forget to take their meds now than before. This is presumably even more true for specialty drugs treating severe conditions, thus patients and doctors are more motivated to ensure ongoing compliance.
- Patient-centric Med-Tech could underperform near-term as elective surgical volumes decline. Bigger ticket items could also suffer as hospital capex projects are delayed with leadership focused on other, more pressing matters. Critical care equipment providers may see a bolus of demand if production can be ramped in a reasonable timeframe. Diagnostics providers exposed to respiratory testing could see increased placements and a bolus of testing volumes.
- Dental may struggle as patients defer visits through social distancing and then, longer-term, consumers may seek to reduce out of pocket or discretionary expenditures in the event that they are directly impacted by the economic fallout.
- The same goes for hearing aid suppliers, which are quasi retail companies serving an elderly population. They could suffer greatly in the short-term. Pharmacies make money on wellness and beauty and happen to serve prescriptions. They probably won’t fare as well as you might imagine, but pharmaceutical wholesalers (Distributors) should fare okay as they operate largely on a fee-for-service basis.”
BBH: Comprehensive Covid-19 update from BB Healthcare