However, many of Australia’s leading healthcare companies are not just a ‘big fish in a small pond’ but are also global leaders in their respective fields. This includes former government spinoff and biotechnology juggernaut CSL Limited (ASX: CSL), hearing implant specialist Cochlear (ASX: COH), sleep apnea device manufacturer Resmed (ASX: RMD), and disinfection device developer Nanosonics (ASX: NAN). Each of these businesses has successfully expanded its operations around the globe, driving much higher growth and profitability than investors would typically expect from companies in the healthcare industry.

Not all healthcare companies on the ASX are global champions and not all have been successful in their overseas endeavours. Ramsay Health Care (ASX: RHC), for example, has had difficulties navigating the more complex and government-controlled economies in places like France, when attempting to replicate its private hospital model. Nor are all ASX healthcare businesses capable of producing high growth rates. NIB Holdings (ASX: NHF) has managed to deliver very attractive returns for shareholders based on a strategy of taking market share in the private health insurance industry, but Medibank (ASX: MPL) has generated a meagre 1.5% compound annual growth rate (CAGR) in revenue since its IPO, given how high its market share was 8 years ago. While capital growth has not been remarkable, Medibank’s total shareholder return has still been above the market over this time though, supported by consistent profitability and a strong dividend.

There’s no doubt that the Australian healthcare industry can provide interesting opportunities for patient, long-term investors – if shares can be bought at the right price. To align with TAMIM’s principle of “buying well,” it’s important to recognise that investing in healthcare is not a free pass to buy at any valuation.

A Pandemic Beneficiary

Demand for pathology services continues to grow as medical professionals request more testing, the type and availability of testing continues to expand, the population in Sonic’s target markets continues to age, and pathology testing becomes increasingly outsourced (there is some pressure from government price controls). Radiology services also have strong tailwinds from an ageing population and greater use in diagnostics by medical professionals. Sonic is the undisputed leader with ~37% market share for pathology services, which has caused it to expand into other services (such as radiology) and internationally, including in the large and highly fragmented U.S. market.

Laboratory service providers were major beneficiaries of COVID-19 testing around the world and have experienced a “boom and bust” in their share prices. Investors enthusiastically bid up these companies on the back of extremely high profit margins from testing revenue, and investor enthusiasm has waned as this revenue has dissipated.

Customer feedback is that Visage 7 is a faster and more efficient product relative to what competitors are offering (allowing radiologists to undertake 10-20% more analysis) and its cloud-based deployment has improved reliability and reduced downtime. This has allowed Pro Medicus to win ~7% market share in the U.S., where it is now in 9 of the top 20 best hospitals in the U.S. Its financial metrics are also incredible, with a CAGR in revenue and earnings per share (EPS) of more than 27% over the past decade. Its operating profit margins are among the highest of all listed companies at more than 67% and its capital-light software model means incredibly high returns on capital (approaching 50%) and that the majority of the company’s profits translate into cash.

While it is difficult to come up with enough superlatives for Pro Medicus’ financial performance to date, the downside for investors just discovering the company is the incredibly rich valuation. Indeed, companies in healthcare and those with recurring revenue and strong balance sheets (Pro Medicus has no debt) are undoubtedly worthy of a higher-than-average multiple, the current valuation on PME shares is truly breathtaking at more than 160 times FY 23 EPS and approaching 80 times FY 23 revenue. With a superior product, a huge addressable market and great momentum, the outlook for Pro Medicus appears strong. But at this valuation, caveat emptor (buyer beware)–if there are any hiccups in its future, the share price reaction could be severe.

Proceed but with Caution

Unfortunately, this is no secret to the majority of Australian investors and valuations are currently quite high across the sector. However, the potential long-term rewards mean it’s worth doing the work to take advantage of any opportunities that may arise. Savvy investors should seek opportunities where there is a favourable balance between earnings growth potential and current market valuation, ensuring that investments are made with a clear understanding of the inherent value and future prospects of healthcare companies.