Healthcare in China is in a grim state. But with the government pledged to act and private firms moving in, healthy investment opportunities abound, says James McKeigue.
China is now the world’s second-largest economy. But it’s still got a long way to go before we in the West would recognise it as a ‘developed’ economy.
Here’s just one story that shows why. Last year, notes The Economist, 17 Chinese patients with kidney problems were caught administering ‘DIY dialysis’ with a second-hand machine. They weren’t keen amateur medics. They were just desperate sufferers who’d realised they could club together to buy the machine and still get better care by treating themselves rather than relying on China’s creaking, costly public healthcare system.
It’s one of the worst examples of China’s health system letting its citizens down, but it’s far from the only one. As The Economist reports, such cases are discussed openly in the media, with “routine publication of the latest scandal”. While the situation had been worsening for decades, it was the Sars crisis in 2002 that finally forced officials to accept the problem. One reason the disease spread so quickly was that the prohibitive cost of treatment prevented poor Chinese from seeking help.
It’s not that the Chinese system has collapsed, says Gabriel Wildau in the Financial Times, “but that it has failed to keep up with rapid changes in the nature of health demand”. China used to have the problems of a “very poor agricultural society”; namely, infectious and epidemic diseases and high infant and maternal mortality rates. Mao Tse Tung’s army of “barefoot doctors” – healthcare workers with rudimentary training – conquered many of those problems with hygiene and antibiotics during the first 30 years of the Republic. Indeed, between 1949 and 1978 the average Chinese life expectancy increased from 35 to 68.
However, since the 1980s, China has been turning itself into “a middle-income, rapidly urbanising society”. As a result, hundreds of millions of Chinese have seen their lifestyles transformed, resulting in the rise of ‘first-world’ diseases and chronic conditions often associated with age, which typically cost more to cure. What’s more, the “wealthier and better-educated urban consumers” also demand a higher standard of basic care.
Wealth has also created more visible inequality. The same liberalising reforms of the late 1970s that ushered in the era of economic growth resulted in almost 70% of the population losing access to primary healthcare by the mid 1990s. The old system of employer insurance and clinics on collective farms and in industrial zones was slowly dismantled. Instead, workers get coupons for treatment in large ‘super hospitals’, mostly located in urban areas. The trouble is, the new system was open to corruption and profiteering, says the FT’s Geoff Dyer: “Chinese hospitals suffer from the sort of unfettered capitalism that China has criticised so heavily in Western banks.”
Not only was the new system inefficient, but it was also underfunded. Spending on health by China’s government fell from 3% of GDP in the late 1970s to 2% in 2005, a fraction of typical developed-world spending. As a result, the coupons do not come close to covering the costs of most treatments, especially as China also has the most expensive healthcare relative to average income of any large economy.
It’s not just China
In India the situation is even worse. According to the World Health Organisation (WHO), the government spends less than 0.9% of GDP on healthcare and still faces “unfinished agendas of communicable diseases, child and maternal health”. Shankar Acharya notes in the Business Standard that it’s “somewhat shaming” that even poorer countries, such as Bangladesh, have beaten India on key health indicators, such as infant mortality, over the last 30 years. As a result, 70% of Indian healthcare costs come straight from people’s pockets.
So far, so grim. And experts reckon the underlying problems are set to get worse. One big issue is demographics. Several emerging Asian economies, such as China, Taiwan and Hong Kong, are ageing fast. This will result in an extra burden on their healthcare systems (the elderly typically use three to five times more healthcare services than younger people).
In China in particular the generation whose life expectancies were extended by the barefoot doctors are starting to reach old age. Due to the one-child policy, introduced in 1979, they are also China’s biggest generation. So while the exact figures are disputed, there’s no denying that, as those who were born before 1979 enter retirement, they will be supported by a smaller numbers of workers. By 2025, nearly 28% of China’s population will be 55 years of age or above.
Urbanisation is also putting pressure on healthcare systems. As people move to cities, they get wealthier, but they also eat more junk food and exercise less – which in turn means more Western-type ‘lifestyle diseases’. According to the McKinsey Global Institute, 590 million Indians
will live in cities by 2030, up from 290 million in 2001. The problem is even more severe in China, which is urbanising at a much faster rate. McKinsey estimates that China will have a billion city dwellers in just 20 years’ time.
The boom in healthcare
The good news is that governments are starting to do something about it. More importantly, so are private companies, as they respond to growing demand from consumers. In April 2009, the Chinese government announced reforms of its health service that would include $125bn extra in spending between 2009 and 2011. The reforms aim to give cover to 90% of the Chinese population by 2011 and 100% by 2020. It also promises “a clinic in every village” and government purchases of some key drugs.
But even without government action, the health sector in emerging Asia has experienced rapid growth in recent years. The bulging wallets and rising expectations of the new middle class have seen an explosion of private hospitals and pharmaceutical products. For example, CLSA Asia-Pacific Markets reckons the Chinese healthcare market will be worth $340bn in 2014, up from $120bn in 2006.
This is great news for domestic equipment suppliers and hospital chains. But it’s also music to the ears of established healthcare firms in the West. They’ve seen growth in their home markets flatten out, while patent expiries threaten a number of their blockbuster treatments.
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So which companies are most attractive to investors? China’s aim to open a clinic in every village and move away from a reliance on ‘super hospitals’ will require a major revamp of its medical infrastructure. The market for medical equipment and supplies – excluding drugs – is growing by 9% a year and projected to be worth $3.9bn by 2013. But “excitement over the mouth-watering numbers needs to be tempered by the fact that ‘entry prices’ are often 10% lower than average”, says Peter Foster in The Daily Telegraph. With reforms still underway, it’s hard to assess the impact of regulatory risk and government price controls.
A new frontier for big pharma
Perhaps a better bet is the market for drugs. Medical market research group IMS reckons China will be the fastest-growing pharmaceuticals market for the next few years at least, with sales doubling from £25bn in 2009 to £50bn in 2013. As Meeru Venu notes on Seeking Alpha, “industry leaders in the treatment of several chronic, more Western-style diseases… could all stand to benefit”. But Asia’s biggest issue remains diseases more commonly associated with poverty and a lack of effective public health programmes. Even China still has a problem with tuberculosis, says CLSA, while there are believed to be a million Aids sufferers in the country. But it’s determined to tackle these diseases and earlier this month began vaccinating 100 million children after an uptick in measles cases. Such programmes create opportunities for vaccine producers.
One risk for big drug firms comes from generic products, especially as Chinese medical reforms aim to cut the price of drugs. Yet while government policy may influence the drugs taken by the poor, wealthier citizens are determined to have what they feel are the best cures. Anecdotal evidence suggests if Chinese doctors like a patented drug they will continue to prescribe it even when generics become available. While some have suggested that this is down to corruption, a recent CLSA survey showed that Chinese “hospital drug purchasers and physicians” in fact feel that US and European firms produce the highest-quality pharmaceuticals.
Even at the bottom end of the market where margins are tight Western firms are competing by localising production. GlaxoSmithKline recently invested in two vaccine factories on the mainland, boosted its local sales force, and has unveiled a plan to cap the price of patented medicines in the poorest countries at 25% of the cost in the developed world. For middle-income countries like China it has said it will change the price to reflect the ability to pay. We look at some of the best ways to play Chinese demand for medicines below.
The stocks and funds to buy now
China already has 20,000 hospitals. But to meet its grand plan for expanding coverage, analysts estimate that a further 600 a year will be built between now and 2016. One firm well placed to benefit is British decontamination and sterilisation specialist Synergy Health (LSE: SYR). The company helps medical device makers to sterilise their products. It also processes surgical equipment for hospitals and decontaminates medical waste. It already has deals with Chinese hospitals and equipment manufacturers and is planning to build a network of 13 decontamination facilities within the next three years. Sales for the year to the end of March 2010 rose 4.5% to £286.4m and operating profit rose 12.6% to £40m. Yet the stock is not overly expensive. At 700p a share, its 2011 p/e is 12.3.
On the drugs side, it’s worth considering traditional Chinese medicine (TCM). In China, both are widely used. Indeed, a CLSA survey found that 62% of middle-class consumers preferred TCM, although Western drugs were favoured by doctors. One firm that can benefit is American Oriental Bioengineering (NYSE: AOB). It sells 90 pharmaceutical and health products in China, all based on plant remedies. Its current strategy is aggressively to market its products to China’s vast and underserved rural market. Over the long-term the company’s health food business should grow in line with China’s growing GDP. It has a recognised brand, which should help it to pass on the impact of rising Chinese labour costs and raw material prices to consumers. Sales were up 11.7% in the first half of this year. On a forward p/e of 5.6, this is one of the cheapest ways to play the Chinese medical story.
One firm with a proven ability to cash in on the Chinese government’s commitment to vaccination programmes is Sinovac Biotech (Nasdaq: SVA). In 2009, the Beijing-based vaccine producer was the first firm in the world to receive approval for H1N1 influenza vaccine. So it has a healthy understanding of how the Chinese approval process works. In 2010 Sinovac’s Hepatitis A vaccine was selected by several urban centres for disease control, while it is partnering with government institutions in fighting avian flu and SARS. It also has a robust pipeline, including vaccines for rabies and meningitis. In light of its strong position, the forward p/e of 13 seems reasonable.
For wider-ranging exposure, the Atlantis China Healthcare Fund (020-7638 9192) is an option. It is the first specialist China healthcare fund and typically invests in 30 firms from a universe of 180, listed in the UK, US, Hong Kong or the mainland. It launched in March 2008, and while it struggled during the financial crisis, it has returned 18.75% year-to-date. Its total expense ratio is also competitive at 1.4%.
Smaller Western drug stocks offer another way in. Alliance Pharma (LSE: APH) is an Aim-listed speciality drug company that makes a multi-vitamin product for pregnant women. The company buys licenses for established, niche products, which it then markets and distributes – this saves it from spending lots of money on developing new drugs that then never make it beyond the laboratory. Its model proved very resilient during the crisis with sales increasing 44% to £31m in 2009 – the ninth year in a row that Alliance grew sales and pre-tax profit almost doubled. For now, only around 5% of the company’s sales come from China. However, the firm’s small size means that any slight growth in Chinese volumes will have a more pronounced effect on the price. The firm is relatively cheap on a forward p/e of 11.
The growth of medical tourism
While China and India rush to patch up their healthcare infrastructure, other middle-income countries are becoming top destinations for ‘medical tourists’. Most such tourists are from within the region. For example, wealthy Indonesians will often go elsewhere in Asia, rather than stay in their own country, where world-class medical facilities are in short supply. But custom from the West is growing. Many Americans come to Asia to escape a system where “spending on health care is soaring, yet medical outcomes remain mediocre”, says The Economist. A heart bypass that could cost $130,000 in the US would set you back less than $30,000 in Bangkok. That’s a strong incentive to overcome any instinctive fears of undergoing major surgery in foreign climes. Some US employers have even offered staff the option of having surgery done in Singapore rather than the US.
The trade is significant enough for the Lancet Infectious Diseases journal to have warned in August that medical tourism could cause a “frightening” worldwide epidemic of antibiotic-resistant bacteria. But that may be something we’ll just have to deal with if it happens. The market just keeps growing. At today’s rate of more than 10% a year, it’s set to be worth around $8.5bn in 2013. Singapore, Thailand and India currently account for 90% of the market. But Korea, Taiwan and Malaysia have all outlined plans to attract more medical tourists.
As a result, investments in the sector are hotting up. Kazanah, the Malaysian sovereign wealth fund, recently outbid Indian hospital group Fortis for control of Singaporean hospital operator Parkway Holdings. US hospital operators are also expected to become more active in Asia. While cost is the main driver behind medical tourism, Asia is also establishing centres of excellence in certain niches. For example, Thailand is world renowned for its cardiology. Indeed, with new Asian hospitals not suffering from the decrepit buildings, old equipment, and politicised unions of their Western peers, it is quite possible that they will “leapfrog their American counterparts”.
• This article was originally published in MoneyWeek magazine issue number 505 on 24 September 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don’t miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.