S&P Eyes Healthcare M&A

06/05/2015 9:00 am EST

Focus: STOCKS

Todd Rosenbluth

Senior Director of ETF & Mutual Fund Research, CFRA Research

S&P Capital IQ sees positive longer-term fundamentals for the healthcare equipment & supplies industry, explains Todd Rosenbluth, director of ETF Research at S&P Capital IQ in The Outlook.

Factors behind this view include increasing demand for quality healthcare, an aging population, and rising R&D outlays, leading to a steady flow of new diagnostic and therapeutic products.

Further, improving US regulatory approval trends serve as a catalyst, spurring new potential revenue streams. Lastly, we believe there are a number of companies that could be candidates for takeover in the consolidating industry.

While the US market is the world's largest and most profitable, S&P Capital IQ thinks there are significant growth opportunities overseas for medical device companies, particularly in emerging markets where the middle class is expanding, GDP is rising, and investments in healthcare are increasing.

Meanwhile, merger and acquisition activity has been increasing within the healthcare equipment and supplies industry in recent years. Healthcare equipment and supplies industry M&A deal count rose to 71 in 2014, marking the busiest period since 2011 when 74 deals were announced.

We think investors should look to small- and mid-caps that could make for easier tuck-in deals by large-cap healthcare companies and yet boost their growth prospects.

The following companies have market capitalizations below $5 billion and are considered undervalued based on S&P Capital IQ Fair Value.

Align Technology (ALGN)

Align—an S&P mid-cap 400 company—designs, manufactures, and markets Invisalign, a proprietary system for treating malocclusion, or the misalignment of teeth.

Haemonics (HAE)

Haemonics—an S&P small-cap 600 constituent—develops and manufactures blood processing technology; its systems help ensure a safe and adequate blood supply.

Masimo Corp. (MASI)

Masimo—an S&P small-cap 600 constituent—develops, manufactures, and markets noninvasive monitoring technologies for oxygen levels and pulse and respiration rates.

In addition, exposure to small- and mid-cap healthcare equipment and supplies companies can also be obtained through SPDR S&P Health Care Equipment (XHE), an equally-weighted ETF with 66 holdings and a 0.35% expense ratio.

While it has some exposure to large-caps such as Medtronic, the ETF's median market cap is $1.9 billion. Two-thirds of the assets are in small- and mid-caps, including ALGN and MASI.

Another alternative is PowerShares S&P SmallCap Health Care Portfolio (PSCH), which is diversified across various health care industries.

Healthcare equipment and supplies is its largest weighting with 37% of assets, ahead of healthcare providers and services (29%) and pharmaceuticals (13%). The ETF has a 0.29% expense ratio and trades more actively than XHE.

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