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4 January 2019
Healthcare Technology & DistributionLH’s more diversified platform despite continued headwinds in core LCD,
with strong CF generation offering capital deployment flexibility, particularly
relevant given its role as a leading consolidator of smaller lab operations in
a post-PAMA world.

PetMed Express (PETS, Underperform):
We remain negatively biased on
PETS on LT structural headwinds, particularly given a recent shift to offline
advertising. While shares fell 47% in 2018, we view room for further
downside as customer acquisition costs escalate, with risks to our call
including industry consolidation, among other catalysts.
4 January 2019
Healthcare Technology & DistributionOur Recommendations for 2019
While variables remain across an evolving healthcare continuum, with a challenging drug
utilization environment, compounded by uncertainty around potential initiatives out of
Washington, we view there are opportunities across our Healthcare Technology &
Distribution universe, particularly with meaningful recent valuation contraction across the
group. Our focus is on company-specific drivers in ancillary business units and strategic
positioning efforts for our traditional Pharmaceutical Supply Chain companies in 2019. We
also continue to view less conventional healthcare names as attractive such as Animal
Health where fundamentals remain strong, and for CROs, we favor companies that can
leverage global data assets in what we view as a robust backdrop. New strategic focus for
Dental companies is inspiring in a glacially recovering demand environment. We also
recognize opportunities with recent commercial contract shifts in a consolidating clinical
laboratory landscape. Below we provide a summary of our best ideas across our broad
coverage universe heading into 2019.
Figure 1: Healthcare Subsector Performances
2011201220132014
Managed Care34.6%Biotechnology57.6%Specialty Pharma91.7%Managed Care42.6%
Biotechnology29.1%Hospitals37.3%
Drug Retailers & PBMs81.2%
Biotechnology38.8%
Specialty Pharma27.9%Diagnostics32.8%Biotechnology71.4%Specialty Pharma37.3%
Large Cap Pharma13.2%
Drug Retailers & PBMs32.7%Drug Distributors63.8%
Hospitals36.9%
Drug Retailers & PBMs8.9%Contract Services37.2%Healthcare Technology46.1%Drug Retailers & PBMs29.1%
Drug Distributors8.6%Animal Health27.7%Contract Services57.1%
Medical Devices28.1%
Healthcare Technology7.6%
Life Science Tools26.5%Hospitals44.0%
Animal Health19.7%
Clinical Laboratories2.7%
Medical Devices16.9%Medical Devices40.9%Diagnostics26.1%
S&P 500 Index0.0%
Drug Distributors14.0%
Managed Care40.3%
Drug Distributors25.9%
Animal Health-2.4%
S&P 500 Index13.4%Life Science Tools38.7%
Contract Services22.1%
Medical Devices-4.1%
Healthcare Technology3.2%Dental*37.0%Dental*23.9%
Dental*-8.9%
Specialty Pharma9.0%S&P 500 Index29.6%
Clinical Laboratories21.7%
Contract Services-3.9%
Large Cap Pharma7.5%Diagnostics28.5%Large Cap Pharma14.0%
Diagnostics-12.3%
Dental*6.7%
Large Cap Pharma27.1%Life Science Tools11.5%
Life Science Tools-14.6%Managed Care5.9%
Animal Health24.0%
S&P 500 Index11.4%
Hospitals-21.8%
Clinical Laboratories0.6%Clinical Laboratories-1.3%Healthcare Technology-6.6%
2015201620172018
Contract Services42.0%Animal Health24.6%
Managed Care47.5%Diagnostics19.6%
Managed Care19.8%
Clinical Laboratories16.5%
Life Science Tools40.5%Managed Care17.5%
Animal Health11.4%
Managed Care12.1%Diagnostics40.5%
Healthcare Technology17.5%
Diagnostics16.7%Medical Devices11.1%
Contract Services28.7%
Medical Devices17.3%
Dental*14.3%
S&P 500 Index9.5%
Animal Health35.5%
Large Cap Pharma9.7%
Life Science Tools14.0%
Healthcare Technology4.6%
Medical Devices22.5%
Animal Health2.6%
Clinical Laboratories10.3%Contract Services10.0%
Biotechnology22.3%
Contract Services2.5%
Drug Retailers & PBMs7.9%
Life Science Tools4.3%
Healthcare Technology30.6%
Life Science Tools2.3%
Medical Devices7.7%
Dental*3.0%
S&P 500 Index19.4%Hospitals-6.0%
Biotechnology7.6%Large Cap Pharma-1.4%
Dental*16.9%
S&P 500 Index-6.2%
Drug Distributors6.9%Drug Retailers & PBMs-9.6%Clinical Laboratories15.7%
Biotechnology-8.6%
Specialty Pharma3.8%Diagnostics-14.8%Large Cap Pharma10.9%
Drug Retailers & PBMs-14.0%
Large Cap Pharma2.2%Biotechnology-21.9%
Drug Distributors4.5%
Specialty Pharma-14.7%
Healthcare Technology1.5%Drug Distributors-24.3%
Hospitals-3.8%
Clinical Laboratories-18.1%
S&P 500 Index-0.7%Hospitals-29.9%Specialty Pharma-12.8%
Dental*-21.7%
Hospitals-17.9%Specialty Pharma-36.2%
Drug Retailers & PBMs-22.0%Drug Distributors-25.1%
Source: Company data, Credit Suisse estimates, Factset, *Dental excludes Align Technology
Pharmaceutical Supply Chain
Investor conversations have largely centered on respective strategic repositioning tactics
with M&A and JVs/partnerships related to ancillary business or services, broader vertical
integration, regulatory scrutiny, as well as underlying drug pricing and utilization dynamics,
all of which will continue to be themes in 2019. We explore these topics further below.
More specifically, as it relates to
the
drug distributors,
despite a continuing lackluster
utilization environment, we are incrementally optimistic as we head into 2019 on a
stabilizing generic pricing environment, as well as an incrementally healthier branded price
inflation landscape than previously expected (or at least better visibility thereon), potential
sources of near term relief. That said, we continue to favor distributors with exposure to
faster-growing, higher-margin ancillary services (e.g.,
AmerisourceBergen
, Outperform),
4 January 2019
Healthcare Technology & Distributionwhich should provide diversification from drug utilization/pricing, while also providing
higher growth potential longer term.
Meanwhile, focus across the
PBMs and pharmacies
has been on strategic repositioning,
including completed vertical transactions and JVs/partnerships across the healthcare
services continuum, with focus also on the next potential larger scale transaction. While
transformational efforts may have been perceived as a competitive response to Amazon
headlines over the past year+, compounded by drug pricing and regulatory scrutiny,major
vertical mergers such as CVS/Aetna uniquely address all-important dynamics around 'total
cost of care'.
Key Theme #1: Political & Regulatory Environment—Political gridlock
favorable for Supply Chain names
Relative to 2018, we view the 2019 regulatory landscape as somewhat more benign given
a Congressional gridlock and lame-duck President scenario, albeit with potentially some
headline risk associated with the recent ACA scrutiny, as well as policy proposals from
relevant government organizations, particularly on drug pricing.
Broader
healthcare legislation
was a key focus in 2018, where a Republican-led
Congress, in conjunction with Republican President Trump, drove cautiousness related to
a potential ACA repeal and replace, drug pricing, among other healthcare debates that
weighed considerably on supply chain names. However, as we look forward to 2019, we
downplay political risk and highlight the midterm elections, where a House/Senate majority
split will likely drive political gridlock, preventing successful transformational healthcare
reform. Moreover, we view a Democrat-led House will steadfastly avoid striking
transformative deals with President Trump ahead of an election cycle, where the President
could utilize any meaningful legislative victories as a selling point. All in all, we view this
political gridlock as favorable to industry constituents across our universe, offering
enhanced visibility (or at least minimizing volatility) and likely halting any meaningful
changes over the medium-term.
While legislative gridlock offers potential stability from larger scale healthcare reform, the
recent ruling by U.S. District Court Judge Reed O’Connor in Fort Worth, Texas, on the
constitutionality of the Affordable Care Act
(or lack thereof) will remain a headline risk
into 2019. According to our legal expert, Neil Seigel, the most recent ACA challenge is the
weakest yet and extraordinarily unlikely to stand given the lack of clear injury, erroneous
focus on the 2010 Congress’ intent (vs. 2017 Congress), and aggressive non-severance
posture. Though Seigel views the challenge will be overturned and the ACA will remain
status quo, the timing of the appeal process and ensuing decision are less clear, with
potentially multiple hearings ahead of a final resolution (by ~2020 timeframe, in our view).
As a reminder, on December 14th, US District Court Judge Reed O’Connor in Fort Worth,
Texas, ruled that the ACA’s individual mandate is unconstitutional once the mandate’s
penalty drops to $0, given the ACA’s constitutionality was once upheld under Congress’
taxing authority. While we are inclined to believe the ACA will remain standing, in line with
Seigel’s view, we highlight relevant ACA-related commentary from industry constituents in
light of potential headline risk into 2019.。