Citi's top ASX healthcare pick ahead of February earnings season

The earnings previews are coming in thick and fast from the sell-side. Today, Citi’s Australian health analyst Mathieu Chevrier has released his latest thoughts on the ASX healthcare sector. And while the past year has been a challenge for healthcare stock returns, Chevrier believes there are brighter days on the horizon for companies that can generate revenues independent of the economic cycle. 

A slew of short-lived headwinds?

The biggest theme of the last three years has been health-dominated. From an investment perspective, the COVID-19 pandemic created a major tailwind for  many ASX-listed healthcare providers. Think Sonic Healthcare (ASX: SHL) and Australian Clinical Labs (ASX: ACL), for example, which both benefitted as COVID-19 testing surged during 2020 and 2021. 

That said, the past three years hasn’t been a windfall for all. Supply chain problems dogged names like ResMed (ASX: RMD), while lockdowns prevented CSL (ASX: CSL) from executing its flagship product. 

In 2023, the Australian healthcare sector is facing two headwinds. The short-term headwind (arguably) is the Chinese reopening. The long-term headwind is the impact inflation has on production. But as Chevrier explains, that just makes company selection that little bit more specific:

“Whilst long-term rates seem to have found an equilibrium, inflation remains an issue and we continue to prefer product manufacturers over service providers given they are less reliant on government funding and have lower exposure to healthcare labour shortages,” Chevrier wrote in a client note.

The big themes shared by the top picks

The top three ASX healthcare stocks, in Chevrier’s view, share two big themes. They have pricing power and resilient demand, which should offset the negative impact of inflation and/or a potential recession, at least to some degree.

So, in reverse order:

3. Fisher and Paykel Healthcare (ASX: FPH) - BUY (Price target: NZ$27/share)

“We view the current valuation as an attractive entry point for a high-quality business (large underpenetrated markets, limited competition, high margins) that would deliver sustainable double-digit EPS growth throughout economic cycles,” Chevrier wrote.

2. ResMed (ASX: RMD) - BUY (Price target: $37/share)

“ResMed continues to benefit from the Philips CPAP device recall. RMD also flagged that it will have the capacity to supply the entire market once the availability of semiconductors improves – we believe this reduces the likelihood of a quick return to market by Philips,” Chevrier argued.- ResMed was also recently upgraded to a BUY by the broker, with a new price target of $37 a share.

And at number one…

1. CSL (ASX: CSL) - BUY (Price target: $335/share)

“Near term, we are focused on plasma collection, recovery in Vifor sales post-covid, the Argenx CIDP P3 trial data in Q2’23, and the transition to the Terumo plasma collection devices in 2H CY23. The 1H23 result will have added complexities from one-offs and changed segments reporting format,” Chevrier wrote.

And now, three to be wary of

But it’s not all good news. Chevrier argues that some of the other notable ASX healthcare names are at risk of disappointing on earnings guidance. 

For example, Ramsay Health Care (ASX: RHC) and Integral Diagnostics (ASX: IDX) provided trading updates but didn’t provide earnings guidance due to the uncertainty around COVID-19 and the pace of recovery of their businesses. 

Cochlear (ASX: COH), on the other hand, could be hit if the pace and severity of China’s COVID-19 reopening changes dramatically. And while the second half is likely to be better than the first half, a lack of guidance and some currency challenges could also pose problems for Pro Medicus (ASX: PME). That stock is rated as NEUTRAL, but it’s also the least-preferred neutral rated healthcare stock in Citi’s spectrum.