Drug pricing scandal: Pharma’s loss is medtech’s gain

The scandal swirling round drug pricing is pushing investors to medical device stocks in lieu of pharmaceutical and biotech plays.

Edwards Lifesciences (NYSE:EW), Boston Scientific (NYSE:BSX) and Becton Dickinson & Co. (NYSE:BDX) shares have outperformed the broad healthcare sector, and especially pharmaceutical and biotech shares, since U.S. presidential candidate Hillary Clinton tweeted she planned to address specialty drug “price gouging” 2 months ago. Since Clinton’s tweet, the S&P 500 Health Care Equipment index, which includes large medical device companies, has climbed more than 5%, against a 1.5% increase for the S&P 500 healthcare index.

“They may not be completely safe, but I think there is less risk with the device companies than with the big biotech and pharma companies,” George Strietmann, a portfolio manager with Cincinnati investment advisory firm Bahl & Gaynor, told Reuters.

Strietmann likes Medtronic (NYSE:MDT), Stryker (NYSE:SYK) and Becton Dickinson and his firm is underweight on biotech and pharma stocks in its growth portfolios, but overweight on medical technology stocks.

Medtronic, Baxter (NYSE:BAX) and Abbott (NYSE:ABT) Laboratories have also gained at least 4%. Diagnostic equipment companies such as Thermo Fisher (NYSE:TMO) and PerkinElmer Inc. (NYSE:PKI) climbed sharply over that time.

Contrast that to the NASDAQ Biotechnology index, which is off more than 5% since Clinton’s tweet. The NYSE Arca Pharmaceutical index is down more than 2%, dragged down by the likes of Valeant Pharmaceuticals (NYSE:VRX, TSE:VRX) and Covidien spinout Mallinckrodt plc (NYSE: MNK) that have been criticized for pricing practices and targeted by short-sellers.

Other factors could be driving the diverging stock performances beyond the political pressures, and Morningstar analyst Debbie Wang pointed to a solid 3rd-quarter earnings season as helping device companies.

But RBC Capital Markets analyst Glenn Novarro told the news service that his phone has been ringing in the wake of the drug pricing publicity.

“Based on the incoming call volume, there’s greater interest in medtech today than earlier in the year,” Novarro said.

Prices for commonly used branded drugs more than doubled from 2008-2014, according to benefit manager Express Scripts. Price tags of $100,000 or more for new therapies for cancer and other conditions, as well as recent massive increases on old medicines put the industry in the spotlight.

Prices for medical devices such as stents, pacemakers and knee replacements have fallen 2% to 3% annually over the past 5 years, according to Novarro, as hospitals seek to cut their costs.

Investors and analysts pointed to several favorable factors for investing in medtech, including an aging U.S. population and increased demand from growing middle classes in emerging markets. Recent acquisitions, by companies such as Medtronic and Zimmer Biomet (NYSE:ZBH), stand to benefit those companies and could be a prelude to further consolidation, Novarro told Reuters.

But the lack of pricing power also could be seen as a negative sign for the medical device industry, potentially reflecting a lack of significant innovations.

“I really don’t see a whole lot of product differentiation” in areas such orthopedics and interventional cardiology, said John Fraunces, co-manager for the Turner Investments medical sciences fund in Berwyn, Pa.

Any bump that medtech shares get on worries about a clampdown on drug pricing may not last – and the worst fears of pharma pricing limits may never be realized.

“It’s more of a headline risk than a real risk,” said Jason Ware, chief investment officer at Albion Financial Group in Salt Lake City. Ware said his company remains overweight in biotech, preferring the growth outlook for companies such as Gilead over the medtech sector.

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