Healthcare has been lagging the market, but that is now changing.
As biotechs consolidate, other healthcare industry groups are powering the sector to a breakout.
Medical Devices and Services are poised to benefit from overarching trends and pent-up demand.
3 healthcare stocks that we believe remain poised to outperform
It is prudent to maintain healthcare exposure at this time.

Healthcare has been lagging the broader market significantly. After underperforming during 2020, the sector has been consolidating since mid-January. As of April 1, the S&P Healthcare Index was up +3% for the year, while the Prudent Healthcare model portfolio was up +25%.

However, the lagging performance is beginning to change. Following a nearly 3-month long consolidation, the healthcare sector is now showing signs of strength and starting to break out to new highs. ~S&P Healthcare Index - XLV

Healthcare accounts for nearly one-fifth of US GDP, and a rapidly strengthening economy will benefit the sector. Biotech, which represents nearly 60% of the sector by company count, has struggled immensely since February. What is notable about the healthcare breakout is that it is occurring in the absence of broad support from biotechs, where the indexes have been struggling and remain around recent lows. Perhaps, a strengthening healthcare advance can presage a turnaround for biotechs as well.

We had asked a similar question in the 2021 Healthcare Outlook earlier this year. Although healthcare has lagged the broader market, strong economic recovery and the growing federal healthcare spending, beyond the pandemic-related spending, will provide a boost to the sector. The issue of evolving healthcare legislation is nothing new and remains an overarching concern for the sector. The introduction of The Prescription Drug Price Relief Act last month continued the push towards lowering drug prices. The pharmaceutical industry is headed towards more regulation to manage healthcare costs, which remains a leading public-interest issue. But it will likely be incremental and over time. We had discussed this along with other concerns in the healthcare outlook.

The biggest issue for biotechs remains the fear of persistently rising interest rates which lowers valuation due to a higher discount rate on future earnings potential. The healthcare sector is breaking out and we believe it will contribute towards turning around biotechs. A catalyst can be biotech-related acquisition activity, as biotech valuations have retreated. After all, the group remains well-positioned, as discussed in the Biotech Bonanza 2021 Outlook report. If biotechs turn around as well in the second quarter, healthcare will join the leading sectors in the market.

Medical Devices and Medical Services are strong healthcare industry groups that have been boosting the sector. Below we highlight 3 stocks from these groups, which we believe stand to strongly benefit from the pent-up demand for healthcare services.

Organogenesis Holdings

Organogenesis (ORGO) is a regenerative medicine company targeting its portfolio of biomaterial products at two market segments, advanced wound care, and surgical and sports biologics.

The company's corporate tagline, empowering healing, quite fittingly captures its business focus. Regenerative medicine is about repairing and organically replacing damaged cells and tissue using tissue engineering and cellular therapy. Biologics refers to products that are created from living organisms or contain parts of living organisms. Organogenesis' empowers and even accelerates healing through its biologics portfolio of products that create a conducive environment for the body to heal and improve patient outcomes.

The products are targeted at a large swath of patients that have repair or regenerative needs, with such markets driven by the aging demographics and rising co-morbidities like obesity, diabetes, cardiovascular disease, etc. ~Product Portfolio

                                                                          Source: Company Reports

The company's bioactive and biomaterials products are applicable in both Advanced Wound Care (AWC) and Surgical & Sports Medicine (SSM) segments, catering to a market that is estimated by the company to be as large as $15 billion. The products are supported by clinical data and studies showing improved patient outcomes, which are important to obtain FDA's Premarket Approval (PMA) and to file for Biologics License Application (BLA). Obtaining PMAs and BLAs are essential for private payor coverage and improves reimbursement rates, both vital for business growth and market penetration. Medicare coverage and reimbursement rates remain a big risk for most healthcare companies, and so it is also for Organogenesis. ~AWC Market

                                                                         Source: Company Reports

In the AWC segment, which includes the fastest-growing skin substitutes market, fourth-quarter (Dec 2020) revenues of $94 million grew 48% over the prior year. It is notable that this rapid growth was achieved in a pandemic quarter when compared to a normal quarter a year before (Dec 2019). The SSM segment, which the company entered through an acquisition in 2017, had revenues of $13 million, which were up 17% from the prior year. According to BioMed GPS, the market for skin substitutes is heavily underpenetrated with less than five percent penetration, which will rise as the proven advantages of skin substitutes become widely known.

Organogenesis operates in an intensely competitive market. A key competitive strength lies in the broader product portfolio serving the two market segments, which also suggests a robust development platform that has more momentum than the competition. ~Competitive Landscape - AWC Market
Competitive Landscape - Sports Market

                                                                         Source: Company Reports

Boosting the favorable market trends of demographics and co-morbidities is the return of the US economy towards growing normalcy in the second half.

It is reasonable to expect AWC related injuries to spurt with rapidly growing economic activity. Also, the pent-up demand for elective surgeries and procedures will further contribute to boosting the wound-healing market. The US and the world have experienced sports activities at a highly suppressed level. That will start to change later this year and as sports activities rise, it will lead to a natural and rapid increase in sports-related injuries to levels before the pandemic.

Organogenesis is well-positioned to benefit from long-term overarching trends and the rapidly rising economic growth this year.

Alphatec Holdings

Alphatec (ATEC) is a medical device company focused on the surgical treatment of spinal disorders to deliver better outcomes. The Company's thrust is on deeper innovation and unique approaches to the field of spinal surgery. ~Alphatec Approaches to Spinal Surgery

                                                                         Source: Company Reports

Its key surgical products integrate into the Alpha InformatiX platform, a neuromonitoring solution designed to reduce the risk of intraoperative nerve injury by offering the surgeon a unified view of relevant and real-time information to improve the predictability and repeatability of outcomes. The company's newer technology, SafeOp, automates Somatosensory Evoked Potential monitoring of nerve health during a surgical procedure. Alphatec has partnered with companies to further enhance its procedural and informational solutions to empower a surgeon. ~Alphatec Solutions

                                                                         Source: Company Reports

The company considers its innovation in spinal surgery to be the driving force that will catapult it to leadership status in the future. Such clinical distinction can create a virtuous cycle whereby spinal surgeons gravitate towards Alphatech through compelling and unique offerings. Alphatech intends to maintain the momentum by planning 8 to 10 new product releases each year. ~Innovation-Driven Growth

                                                                         Source: Company Reports

By focusing on the different sections of the spine and offering unique and highly specialized solutions, which include medical products and biologics to heal, the company is experiencing growing market traction.

Revenues in the fourth quarter (Dec 2020) were $43 million, up 38% over the prior year, with over 75% of the revenues coming from what the company classifies as new products, up from 48% a year ago. Once again, it is noteworthy that this rapid growth was achieved in a pandemic quarter when compared to a normal quarter a year before (Dec 2019). Through the pandemic year 2020, Alphatech achieved an over 30% revenue growth.

Just like for broader hospitalized healthcare, a material portion of elective surgeries was likely deferred in 2020. Hospitals also allocated capital budgets more towards managing the pandemic, deferring the investments in newer technologies. The pandemic year has created pent-up demand, which will begin to manifest itself with each passing quarter this year. Another element that may have diminished surgeon adoption of the Alphatech system would have been the training limitations in a pandemic. This year it is very likely for all these factors to favorably contribute to a step-up in growth. Early indications can be seen in the first quarter preliminary report which showed US revenue growth of over 50% over the first quarter of 2020, a quarter which had not as meaningfully been impacted by the pandemic.

We believe Alphatech is a well-positioned small cap medical devices company that will benefit materially from the broader healthcare trends and a resumption of normal economic activity.

Avid Bioservices

Avid Bioservices (CDMO) is a medical services company that contracts its services to the biopharma industry. When antibodies and proteins need to be developed for trials or sales, contract development and manufacturing organizations are relied upon as partners.

Avid is focused on the process development and CGMP manufacturing of drug substances, like monoclonal antibodies and recombinant proteins, derived from mammalian cell culture. It provides a range of services from clinical to commercial manufacturing. CGMP refers to the FDA-defined current good manufacturing practices in the biopharma industry. Other services include bulk packaging, release and stability testing, and regulatory submissions support. The business is heavily regulated and needs to comply with FDA guidelines. ~Partial View of Avid's CGMP Facility

                                                                         Source: Company Reports

The revenues come from manufacturing contracts and process development. Manufacturing contracts are for a defined quantity of production runs with the customized product being manufactured as per specifications. Process development revenues are typically for the early-stage programs where the company provides services of custom developing the manufacturing process, analytics, optimization, and testing. Revenues are recognized based on the percent of completion, and judgment has to be exercised in estimating revenues.

Biotech venture and public market funding are at an all-time high. Such funding is a precursor to trial activity, which has been growing rapidly and consequently, raising demand for process development and contract manufacturing services. This was evidenced by the growth in Avid's backlog.

For the most recent quarter ended Jan 2021, Avid Bioservices reported revenues of $22 million, up 61% from a year ago Jan 2020 quarter which was unaffected by the pandemic. That is a notable achievement and underscores the business momentum. New business soared as $74 million of contracts were signed during the quarter, with backlog reaching the highest level in the company's history at $120 million.

The company is well-positioned with its services portfolio to capitalize on the booming biopharma trial activity.

Healthcare Should Not Be Ignored

Healthcare has had a much slower start this year compared to most other sectors. However, encouraging signs point to it taking a leading role in the second quarter. The S&P Healthcare Index was up 3% in the first quarter, while the Prudent Healthcare portfolio was up 25%.

Biotechs often take the lead when discussing healthcare investment opportunities due to headline-grabbing advancements and the potential for significant gains. We believe biotechs will be a stronger performer in the second quarter. At the same time, other industry groups within healthcare are gaining momentum and these include Medical Devices and Medical Services.

Investors should consider a broader healthcare exposure in their portfolios. A few of the promising healthcare companies, some of which may be now or in the past be part of Prudent Healthcare or the Prudent Biotech model portfolios, include Organogenesis, Alphatec, Avid Bioservices, Moderna (MRNA), Shockwave Medical (SWAV), Agios Pharmaceuticals (AGIO), Staar Surgical (STAA), Inmode (INMD), Vericel (VCEL), MacroGenics (MGNX), Rubius Therapeutics (RUBY), Acadia Healthcare (ACHC), Intellia Therapeutics (NTLA), Surgery Partners (SGRY), Celldex (CLDX). Anavex Life Sciences (AVXL), Cassava Sciences (SAVA), BioNTech (BNTX), Progyny (PGNY), Prothena (PRTA), AngioDynamics (ANGO), Aclaris Therapeutics (ACRS), Precigen (PGEN), TG Therapeutics (TGTX), Pra Health (PRAH), and Select Medical (SEM).

The article was published on Seeking Alpha.