Health Care Reform and Medical Diagnostic and Research Stocks: Expert Analyst Amit Bhalla Details the Near Term Prospects

Wall Street Transcript

67 WALL STREET, New York - August 23, 2012 - The Wall Street Transcript has just published its Medical Research, Diagnostic Substances and Life Science Tools Report offering a timely review of the sector to serious investors and industry executives. This special feature contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Health Care Consolidation Activity - Cost Reduction and Improving Efficiencies - Chinese CRO Growth - NIH Budget Uncertainty

Companies include: Life Technologies Corporation (LIFE), Agilent Technologies Inc. (A), Thermo Fisher Scientific, Inc. (TMO), Hologic Inc. (HOLX), Illumina Inc. (ILMN), Edwards Lifesciences Corp. (EW), Medtronic, Inc. (MDT) and many others.

In the following excerpt from the Medical Research, Diagnostic Substances and Life Science Tools Report, expert analyst Amit Bhalla discusses the outlook for the sector:

TWST: There are a lot of companies, larger companies that are moving into the diagnostic space, right? That speaks well to the space.

Mr. Bhalla: One of the reasons, I think, is that if you take a look at the direction the health care system is going, it's moving toward lowering cost and providing more effective health care. One of the ways to do that is going to be through more efficient diagnostic testing.

If you think about health care reform, there should be an increase in the number of patients in the health care system and the hospital system, which would mean ultimately greater demand for diagnostic testing. If diagnostic testing is done correctly, it should put patients on a better course of therapy - fewer patients should end up on high-priced, ineffective medication/treatments over time. So what we're really describing here is a move toward personalized medicine and better diagnostic testing.

TWST: Briefly, would you bring us up to speed on the three major end markets, and what's happening in each of those areas?

Mr. Bhalla: Sure. So the three major end markets that you're talking about are the academic/government end markets, the biopharma space, and industrial and applied customers.

We gauge the academic/government end market by looking at the state of the U.S. National Institutes of Health, NIH, as well as European scientific budgets on a country-by-country basis. Historically, the NIH budget has grown in the low single-digit range annually, but overall budget uncertainty for the U.S. government led to a 1% decline in the NIH budget for 2011 and roughly flat for 2012.

Now, we have the overhang of sequestration, which could lead to an 8% budget cut in 2013. Now, an agreement on a continuing resolution was just approved yesterday between the Senate, the House and the president, and that should push the budget debate past the November election, which did not really surprise us. We didn't think that either party wanted to cut scientific research or have a major debate on the budget ahead of the election. We ultimately think in the U.S., the real outcome will not be sequestration, but an NIH budget that's plus or minus 1% for 2013.

In Europe, this is more mixed on a country-by-country basis. Northern Europe has been spending, while we all know the southern European issues. The major northern European regions such as the U.K., France, Germany and the Nordics have been growing their science budgets in the double-digit range. But just over this past earnings season, management commentary has started to show signs that there is a general slowing all around, which is impacting equipment and consumable purchases in this end market in Europe.

I would characterize the academic/government end market, which roughly accounts for about 25% to 30% of the tools and diagnostics segment's revenues, as uncertain. But I think we're going to end up getting a better-than-expected outcome, because investor expectations are so negative right now.

Next, the biopharma end market makes up about 30% of sector revenues. This is essentially R&D budgets from large pharma, biotech, specialty biopharma and generics. When we look at the global pie for R&D spending, we see the pie as growing 1% to 2% a year. What we are also seeing is that the pieces of pie are shifting, but the overall pie still looks to be in that very low, single-digit growth range. The pieces of pie are shifting in that we're seeing large pharma consolidating their R&D budgets, outsourcing more of their R&D to CROs. And generics are becoming a much bigger parts of the R&D pie.

For the tools and diagnostics companies overall, as long as the pie has some relative stability, the movement of the pieces isn't as much of a concern because people are still buying equipment. But in this overall macro slowdown, we are seeing purchasing cycles lengthen for equipment. I would say that the biopharma end market is incrementally weaker than it was a year ago.

The last end market is the industrial and applied end market, which accounts for something in the range of about 40% of sector revenues. A year ago, this end market was really the pillar that was holding up the sector, but we've seen it start to slow considerably. The July ISM reading was 49.8 with new orders in the 48 range. Clearly, those are not positive numbers, compared to a 49.7 reading in June. To put this into context, the ISM reading has been 50-plus for as far back as mid-2009. The reason I bring up the ISM Index is it has been a good one-quarter forward proxy for the tool sector organic revenue growth rate, and this would indicate an overall slowing for the macroeconomy, and subsequently, tool company organic revenue growth rates.

In summary, we see the academic market as under pressure, but likely to be better than the negative sentiment that's out there. We see incrementally weaker outlooks for the biopharma and industrial applied end markets.

TWST: How would you characterize the industry over the past 12 months? How have the stocks performed?

For more from this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers, and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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