Podcast: Where is Veritas finding value in the current market environment?

By Andrew Headley

Listen to the podcast here.

Transcript

Rob: Welcome to the Nedgroup Investments podcast. Today we have Andy Headley from Veritas Asset Management. They've been running our Nedgroup Investments Global Equity Fund and doing a fantastic job. Today, we're going to have a quick chat about a couple of the sectors the Veritas team have been looking at recently.

So, Andy an area you've been focusing on for some time now is health care, and you have, within the managed health care stocks, a few names in your portfolio, but they've struggled recently. What's going on there?

Andrew: Yeah, we've been involved in health care for a long time. We have quite a big weighting in health care. One of the areas that we're focused on is the health care supply chain, health care services.

So we do own a number of names in the MCO [Managed Care Organisation] space of the health management organisations. And the reason we own them is because we think they're extremely cheap. In today's market, it's very difficult to come across companies that are both high quality, growing and cheap. Obviously, with interest rates where they are, it's led to valuations generally across the market being pushed up. So when we're able to find these opportunities, we like to make them reasonable size positions in the portfolio.

Now, one of the things with managed care and our investment in them is that we are looking quite long term here. So one of the reasons that they're cheap is because we're taking a five year view, whereas the market is looking at these things over the next year or two and seeing quite a political risk for the companies. At the moment in the US, which is where these companies primarily operate, we're going through the Democratic primaries to determine who will be the Democratic challenger to Donald Trump in the November 2020 elections. During that process, all of these candidates are making lots of promises around health care. There are actually two camps really within the Democratic field. One is very left-wing and looking to socialise healthcare in the US and one is more moderate, centre ground.

At the moment, one of the candidates, Elizabeth Warren, together with Bernie Sanders, is looking to have what's called Medicare For All, which is taking the whole of US health care (which is a mixture of public and private) and making it all public. This would eliminate health insurance as we know it.

Actually, one of the things that her and Bernie Sanders have suggested is making health insurance and private health insurance illegal in the US. Now, obviously, for our holdings, that would be disastrous if their business was entirely reduced to zero and made illegal. However, we think the chances of this occurring are very, very small, probably a sub 1 percent chance of it occurring within the next 10 years.

Even if Elizabeth Warren becomes the challenger to Donald Trump and then becomes the president, she would not be able to force through these changes because she would require the Democrats to hold Congress and the Senate - and within the Senate, she'd require 60 votes out of 100. So she'd require 60 senators out of 100, which is almost impossible for the Democrats to achieve. Without having 60 votes, she could try and force through some legislation through a process that's called ‘budget reconciliation’. But there's no way that she would be able to eliminate private health insurers under the rules of budget reconciliation. So we think that they're actually fairly certain of surviving this.

We think the solution will be to extend what is currently there, which is very, very good for the health insurers if we saw more extension of what is currently provided under Medicare. So whilst the share prices are discounting to some degree, the fact that the whole business may be made illegal, we think that the chances of that are much less than the market is discounting within the share prices.

Rob: Right. It doesn't really make sense that they'd get rid of that strain of health care provision entirely. Does it? If you think about it, I mean, horses for courses, some people want to go down that route.

Andrew: Absolutely. So if you look at polling in the US, and you ask people whether they'd like free health care, the answer, of course, is always yes. But when you start caveating the question with some facts that would have to occur, so for example: ‘Would you like free health care, if your taxes would have to rise (obviously taxes would have to go up to pay for socialised health care)?’, then people poll very much in favour of no.

Equally, if people are asked whether their own private health insurance should be removed and made illegal, that polls are very unfavourably. So around 70 percent of people who are polled would like to keep their own private health insurance. So, actually, it's very difficult to see this occurring. And on top of that, there's the cost.

At the moment, the total socialised health care has not been costed fully. The last time something similar was costed was Bernie Sanders plan in 2016 when it was costed at $32 trillion over 10 years. So it's a huge cost to the system. This time around, they've added in additional provisions to the health care bill that they're proposing for socialised health care, which includes things like long-term care, dental, and optometry, and this would all add to that 32 trillion. So we're probably near a $40 trillion price tag for 10 years for this socialised health care, ‘Medicare For All’. Now, to put that in some perspective: last year, the federal tax receipts in total were $3.3 trillion. So if you think that this might cost $40 trillion over 10 years and at the moment the federal government raises $3.3 trillion in tax...

Rob: At full employment.

Andrew: Exactly. They would need to raise a huge amount of additional tax revenue to pay for this Medicare For All. So we think for those factors, it's totally unworkable. Not least, people don't really want it, but also the cost factor. And finally, there is the political factor that the Democrats are highly unlikely to control the President, Congress and the Senate and have the 60 percent supermajority that's required in the Senate.

Rob: Right. So you mentioned that predominantly the companies that you hold are businesses in the US. Do they have any exposure outside the US that they can fall back on as well, or is it insignificant?

Andrew: They all have some other businesses. For example, one of the businesses we hold is CVS, which part of it is a health insurer, but equally it has other parts of business. It's a pharmacy business, retail pharmacy, pharmacy shops. It's highly unlikely that they would be affected by this change because people would still need prescriptions, they'd still need to pick prescriptions up from somewhere. So the pharmacy itself would be fine.

If we look at some of the others, United Healthcare has an international business, but it's not very large. The same applies for Cigna. They have an international business again, not very large.

So if this did go through and Elizabeth Warren was able to push through Medicare For All and made health insurance illegal in the US, it would be extremely detrimental to our holdings, but we think the chance of that is around 1 percent or less. It's just highly, highly unlikely that this occurs. These companies are trading on double-digit free cash flow yields, typically sub 10 times, earnings multiples. We have 20 percent plus annualised rates of return that we think we'll achieve in these businesses, and bear in mind that they're only a portion of the portfolio. We hedge ourselves by owning lots of other things that are not healthcare. But we think if we're right here, and there’s a there's a 99 percent chance that we're right, then in these positions, we'll make a 20 percent plus annualised rate of return.

Rob: That's great. Thank you. Do you have any advice for the South African government also looking to embark on this universal healthcare?

Andrew: Not really.

Rob: It's expensive.

Andrew: Well, one of the things that we've looked at is it's really difficult to change from what you've got to something new. So when people look at, for example, Canada and the UK, where we have socialised healthcare, universal healthcare, they forget that we started with that really. We never had private health insurance as a provision. So the health system has grown up in a very different way. And of course, moving from something that is a mixture of private and public to entirely public is a really, really difficult thing to do and will involve a huge dislocation in the sector. It will involve some huge gaps in care for a period whilst it goes through. So there's likely to be turmoil in any country that goes through this for a period of years before it stabilises.

Rob: Okay. Well, thanks very much for joining us today, Andy, and enjoy Cape Town whilst you here.

Andrew: Thanks, Rob.