The outbreak of COVID-19 is both benefiting and challenging the U.S. healthcare industry in ways that will continue to evolve in the coming quarters, according to the Global Healthcare team at Mitsubishi UFJ Financial Group (MUFG). The team issued its perspective on the heels of a wave of first-quarter earnings reports published by major U.S. pharmaceutical companies.

The Industry's Position as a Defensive Sector

"From a macroeconomic perspective, healthcare is considered a defensive sector because it is comparatively non-cyclical: It offers products and services that consumers need and continue to consume in most economic environments," said Andreas Dirnagl, MUFG's Global Head of Healthcare Research at MUFG.

Amid the public health crisis triggered by COVID-19, Dirnagl notes the main reasons why healthcare has come back into favor among investors. "Naturally, there's intense interest in healthcare as a source of treatment and of potential cure for the disease," he said. "Healthcare as a whole is also viewed as a bastion of financial resilience relative to other industries that are suffering because of social distancing—and that will likely continue to suffer in a recessionary environment. These industries include tourism and hospitality, airlines, capital goods, and other industries fueled by discretionary spending and susceptible to economic downturns."

However, when examined more granularly, "the healthcare industry itself is diverse and will be affected in uneven ways by the pandemic," Dirnagl noted.

The Financial Effect of the Pandemic by Sub-Sector

Dirnagl specified the anticipated financial consequences of the pandemic for the healthcare industry's main sub-sectors:

1. Pharmaceutical companies: He suggests that in the short run, social distancing has accelerated the business of pharmaceutical companies because of "shelter-in-place" orders, which resulted in the extension of medication prescriptions—often from 30 to 90 days—to last for prolonged stays at home. Pharma companies with consumer-products businesses have particularly benefited from this trend as sales of over-the-counter drugs (such as pain-relief medication) and a range of household products (such as cleaning agents) have gone up.

Yet Dirnagl said the effect of accelerated purchases during the first half of the year will be offset by a deceleration during the second half as shelter-in-place orders are lifted, thus reducing or neutralizing the net positive effect on companies' annual results for 2020. The exception would be for manufacturers of products and supplies in exceedingly high demand to treat respiratory illnesses—such as ventilators—as well as any company that could manage to produce a successful vaccination against COVID-19. Such companies, he said, may well see a net positive effect on their annual results.
    
2. Medtech: Dirnagl defines medtech companies as producers of technologies, supplies and capital equipment used in a care setting, such as medical and surgical devices and instruments, diagnostic tests, implant materials, biomaterials and disposables. He said the impact of the pandemic on a medtech company would depend on the extent to which its business is dependent on elective procedures (i.e., any surgery that must be done, but that need not be performed immediately).
    
"What we're hearing from some medtech companies is that things were going well until the coronavirus disease reached its apex in the second week of March—and then the bottom fell out," he said. "These are companies that rely on orthopedic, dental, low-acuity cardiac and other procedures, which had to be postponed either because of social-distancing measures, or because hospitals needed to free up resources and preserve capacity for an influx of COVID-19 patients. The real question will be how quickly this loss in volume is recovered once social distancing restrictions begin to be lifted. What many investors may underestimate is the reluctance on the side of patients to return to a clinical setting during a pandemic."
    
3. Healthcare services: Dirnagl defines the services sector as consisting of medical professionals, organizations such as hospitals, and workers who provide medical care to those in need. "The U.S. healthcare services sector makes one of the largest portions of its profits from high-priced, non-emergency procedures and surgical stays. As a result of procedure delays and cancellations, hospitals are hemorrhaging revenues," he said. "Moreover, hospitals are spending large sums of money treating patients, and protecting their staff from the pandemic, and making other necessary preparations—an additional financial burden."
    
He added that even if revenues rebound later in the year, it may take some time—perhaps a few years—until the services sector recovers financially. "What's clear is that governments around the world are setting up financial lifelines for their hospital providers. And if there's one thing a pandemic teaches a government, it's how to value its healthcare infrastructure."

The Effect on the Pharmaceutical Supply Chain
Dirnagl expects the pandemic to have a lasting effect on the supply chain of pharmaceutical companies.

"This pandemic has exposed how dependent the United States is on countries like China for the material sourcing and manufacturing of active pharmaceutical ingredients, or APIs, which are the building blocks of drugs," he said. "It should prompt a reassessment of supply-chain vulnerabilities and lead companies to establish workarounds to reduce their reliance on offshore outsourcing and minimize risks."

The Effect on M&A
Dirnagl expects most merger and acquisition (M&A) activity to be put on hold until companies are able to reassess their financial prospects once the pandemic subsides. "At the onset of COVID-19, healthcare companies emphasized the preservation of liquidity," he said. "I believe that emphasis will continue so long as uncertainty remains about the economy and consumer behavior. Once the immediate impact of the pandemic subsides, we expect strategic, opportunistic and 'tuck-in' acquisitions to be the core of M&A activity in 2020. Healthcare companies are taking a hard look at their portfolios and will be seeking to trim or add to them."

The Effect on Pharmaceutical Public Relations
Dirnagl noted the negative reputation that pharmaceutical companies have had to contend with in recent years until the pandemic hit.

"The perceived steady increase in drug prices and the images of CEOs being summoned to testify in front of congressional committees about it fueled a negative perception of those companies as greedy at the expense of public health," he said, "but COVID-19 has allowed for image rehabilitation. The public now looks to pharma as the solution. This favorable change in attitude was only amplified when manufacturers decided to donate hydroxychloroquine as an experimental cure for the disease, forfeit some profits, and demonstrate that they were being socially responsible."

Dirnagl added that pharmaceutical companies without consumer-product divisions or blockbuster drugs had been relatively obscure until the pandemic brought them to light and enhanced their public relations. "For example, Gilead Sciences was likely not a household name until everyone started talking about its drug remdesivir as a possible treatment for COVID-19," he said. 

The Prospect of a Vaccine
As the search for a vaccine to inoculate the world's population continues, Dirnagl emphasized the risk/reward endeavor it entails for pharmaceutical companies.

"It's a business of dichotomous outcomes in that the result is binary: Either you manage to synthesize an effective, commercializable drug following a tremendous financial undertaking of research and development—or you don't," he said. "It's the kind of risk/reward profile that pharma companies and their investors must assume and be comfortable with in the process."

Dirnagl added that a successful vaccine would face monumental global demand in the form of hundreds of millions—and perhaps billions—of doses. "Given its odds of success, the pursuit of a COVID-19 vaccine can't be a foundational, long-term business strategy of a company," he said, "but if the opportunity presents itself for an established company to try, the financial benefit could be enormous."

MUFG is the world's largest publicly traded financial institution and fifth-largest by assets, with approximately $2.9 trillion. Its U.S. Healthcare Banking team is based in New York and comprises 12 bankers serving more than 100 large and middle-market corporate clients throughout the country.