Investing in Chinese Healthcare Stocks May Come at a High Cost

The Aging Population in China and the Knowledge Gained From the Pandemic are Likely To Lead To Increased spending on healthcare. Companies that Specialize In Medical Devices Will Benefit From This, But Their Stocks Will not Be Inexpensive.

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After a lengthy period of time, China has decided to move away from its stringent zero-Covid policy. This serves as a reminder that the nation's healthcare system still requires improvement. According to the World Health Organization, China spent 5.4% of its gross domestic product on healthcare in 2019, which is a typical amount for a middle-income country. As the population of China is aging, the government is implementing policies to strengthen its healthcare infrastructure. This week, the country reported its first population decrease in sixty years.

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In the past couple of years, China has seen a dramatic increase in both imports and exports of medical devices and equipment. The global demand for personal protective equipment, such as masks, has been a major factor in the rise of exports. Additionally, exports of more advanced medical devices, such as CT scanners and ventilators, have also seen a significant increase. According to Nomura, exports of these devices, excluding Covid-related products, rose 28% year-over-year in 2020.

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Despite the fact that foreign companies such as Medtronic and Siemens Healthineers still control the majority of China's high-end medical device market, Chinese companies have been making progress in areas such as imaging machines, patient monitors, and single-use items like coronary stents. With Beijing's growing emphasis on self-sufficiency, increased investment in medical infrastructure will benefit domestic companies that can provide suitable alternatives to foreign products.

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In recent years, China has implemented a volume-based procurement policy to reduce the cost of medical supplies such as implants for hospitals. This has been successful, with the last three national procurement rounds resulting in a 82% decrease in the price of artificial joint implants and a 93% decrease in the price of coronary stents, according to Nomura. As a result, most of the winning bids have been from Chinese companies, leading to increased order volume for domestic firms, but at the expense of lower margins. Companies that focus on commoditized segments where firms compete solely on price may be at risk of further margin compression in China.
Organizations that offer more expensive goods that can compete on an international level may gain significantly if China's healthcare spending continues to increase. Shenzhen Mindray Bio-Medical Electronics 300760 -0.65% is an example of this.

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Mindray is a major player in the Chinese market for medical devices such as patient monitors, ventilators, and defibrillators. Goldman Sachs reported that Mindray held more than half of the Chinese procurement market for patient monitors in the first nine months of 2022. Additionally, 40% of its revenue in 2021 was generated from international sources. Shenzhen New Industries Biomedical Engineering, or Snibe, is also a prominent domestic provider of in-vitro diagnostic instruments and products. Both Mindray and Snibe have high valuations, with Mindray trading at 42 times forward earnings and Snibe trading at 35 times, as reported by FactSet. This is significantly higher than the valuations of Medtronic and Siemens Healthineers, which are 15 times and 24 times, respectively.

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It is expected that healthcare spending in China will continue to increase, even if the country's overall growth rate slows down after the pandemic. Investors who are interested in investing in the sector may need to pay a premium for access to the leading domestic companies.