Don’t be fooled by the value trap in Malaysia’s healthcare sector

THE healthcare sector undeniably has played a leading role in combating the unprecedented Covid-19 outbreak. Certain Malaysian healthcare companies (most notably glove manufacturers) have benefitted along the way as strong demand for healthcare products boosted revenues and profits.

Along the way, their share prices skyrocketed and helped push the Bursa Healthcare Index to almost quadruple from the pandemic lows to the peak in August 2020, outperforming the broader KLCI Index resoundingly.

However, a rotation away from pandemic-beneficiaries toward the beaten down reopening counters was initiated since 4Q20. The healthcare names were not spared from a pullback and saw a large part of the run-up erased since then.

While many had been expecting the public health crisis to finally come to an end in 2021, the recent delta variant resurgence once again put the global reopening in jeopardy and clouded the economic comeback in 2H21. With that, the healthcare theme has once again returned to headlines.

Some of you might ask: After such a massive correction, is the healthcare sector worth taking a look now? We seek to answer your question in this article.

Firstly, Malaysia’s healthcare sector can be further segmented into two main subsegments – health care equipment and services companies (glove makers) and healthcare providers (hospitals) which contribute 54.35 and 41.84 per cent to the Bursa Health Care Index respectively.

Each sector has its unique drivers which would require different analyses.

1. Health care equipment and services companies 

Prior to the outbreak of Covid-19, the glove industry had seen a steady growth of eight per cent in terms of cumulative annual growth rate (CAGR), due to structural factors such as the growth of the human population, ageing population, and increase of health and hygiene awareness which had led to rising usage of gloves especially in developing countries.

Then, the glove industry experienced a boom in 2020, where the Covid-19 pandemic led to a huge spike in demand for disposable medical gloves from both the general public and healthcare professionals.

With the backdrop of the virus’ resurgence and detection of new variants across the globe, the demand for gloves for the next one to two years is expected to remain high as gloves are part of the essential PPE that continue to be needed by frontliners and healthcare workers under the new normalcy.

Additionally, the ongoing vaccination programme also requires the use of medical gloves, and thereby the global demand for gloves is likely to stay at a high level until the world population is fully vaccinated and the virus is fully eradicated.

Once the vaccination rates ramped up and more countries achieve herd immunity against the virus, global glove demand is expected to taper, but continue to stay above the global demand level prior to the Covid-19 outbreak.

Beyond the Covid-19 pandemic, it is envisaged that glove demand could stay at a high level due to the growing awareness among the public in the wake of the pandemic.

Covid-19 has triggered the public to be more aware of the need to maintain hygiene, at a personal level as well as at home, to reduce the chances of infection and this is expected to become a trend in the long run.

On a broader basis, the hygiene and healthcare awareness has accelerated significantly especially for developing countries during the pandemic, and thus it has driven up the glove consumption in those countries which previously had lower glove usage such as Indonesia and India while compared to the developed countries.

Undoubtedly, the pandemic has raised public healthcare awareness and led to greater and speedier growth in the healthcare industry. The increased healthcare standards in emerging economies, growing government expenditure on healthcare reform, increasing awareness of health-related issues and an ageing population in the developed and emerging economies will continue to drive the industry’s expansion.

Meanwhile, we opine that the wider adoption of glove usage by non-medical industries such as food and beverage, services and retail would be another tailwind for the glove industry.

However, supply is expected to flood markets in the coming years as glove makers aggressively increase production capacity.

The temporary situation where demand outstrips supply is expected to underpin the glove company performances until at least this year. However, given the plan of increasing production capacity massively, the gap between supply and demand is foreseen to narrow whereas the current shortage of gloves is expected to ease in the near future.

The five biggest global glove makers (Top Glove, Hartalega, Supermax, Kossan and Sri Trang from Thailand) have been ramping up their production capacity aggressively since the outbreak of Covid-19 in order to cater to the greater demand across the globe.

Based on the projection, these companies are planning to increase the production from 231 billion pieces per annum in 2020 to 463.5 billion pieces per annum in 2024. These forecasts have not taken into account the production increases of smaller players.

Additionally, the competition in the glove sector has intensified as more non-traditional glove companies have ventured into glove production to ride on this secular trend, adding further supply to the market.

As a result, we think that it will eventually develop into a downward pressure on the average selling price of gloves and hence the margins and profits of glove companies down the road.

2. Healthcare providers 

The outbreak of Covid-19 has presented unprecedented challenges to the global economy, across all industries, including those healthcare providers.

Patient volume came in at a softer reading as compared to the period before the virus outbreak, mainly attributed to the postponement of non-urgent treatment and visits to hospitals and healthcare facilities.

However, the fall of revenues in the healthcare provider industry was cushioned partly by the contributions from Covid-19 related services rendered.

In the near-term, prospects for healthcare provider are expected to remain resilient supported by their active collaboration with the public healthcare sector to provide Covid-19 screening services, laboratory testing, and assist the governments in administering Covid-19 vaccine to its residents.

Beyond the pandemic, patients who intentionally delayed in seeking treatment at hospitals previously due to the fear of Covid-19 infection will likely return to the hospital and receive treatment, and thus recoups the pandemic-driven losses.

Investors should not be fooled by the value trap in the Malaysian healthcare sector, as the cheaper valuation is mainly attributed to the supernormal earnings during the pandemic.

Going forward, in a post-pandemic world, we foresee the tapering of global glove demand and given the massive increases in production capacity, supply would outstrip demand over the next few years.

Subsequently, this would weigh down the glove’s average selling price and margins for glove makers, and result in a normalisation of profits. On the other hand, the recovery in healthcare services providers may not be enough to cushion the drop in earnings for the glove makers.

With that, we expect negative earnings growth of 54.1 and 24.4 per cent for FY22 and FY23 respectively for the healthcare sector. Negative earnings growth could possibly continue to weigh on the market sentiment and inflict more pain to the healthcare sector.