IHI: Poor Price Performance May Be Temporary (NYSEARCA:IHI)

When I covered iShares U.S. Medical Devices ETF (NYSEARCA:IHI) last time, the last traded price was $59.69. After 11 weeks the stock is trading around $51, a drop of almost 14 percent. This fund replicates the investments of Dow Jones U.S. Select Medical Equipment Index and invests in public equity shares of companies primarily engaged in healthcare equipment and medical devices.

The price fall occurred majorly during the past one month, primarily due to negative returns of almost all the stocks in its portfolio. IHI has a portfolio of 67 stocks, out of which 15 stocks hold 85 percent of total investments. Unfortunately, all these 15 stocks suffered price loss. As a result, IHI’s price dropped by 14.03 percent in the past one month

In my opinion, this is a temporary phenomenon. If we consider the past 12 months, when the healthcare sector has performed poorly, and almost all the healthcare funds have generated negative returns (including IHI), seven out of the above 15 stocks that hold 35 percent of IHI’s portfolio, generated positive returns. Thermo Fisher Scientific Inc. (TMO), Becton, Dickinson and Company (BDX), Edwards Lifesciences Corporation (EW), ResMed Inc. (RMD), STERIS plc (STE), Waters Corporation (WAT), and Hologic, Inc. (HOLX) together pulled up the return of IHI to record a negative growth of 7.9 percent.

In my last coverage, I discussed in detail how this ETF generated an exceptionally good performance over the medium and long run, and was able to successfully overcome the Covid-19 pandemic related market slowdown. iShares U.S. Medical Devices ETF has recorded a price growth of almost 39 percent, 96 percent, and 367 percent over the past 3 years, 5 years, and 10 years, respectively. Since its inception in May 2006 (16 years ago), this fund has generated a return of 539 percent, i.e., a CAGR of 28.3 percent.

I also mentioned in my last coverage that IHI:

“might be a rarest fund in which all its significant holdings generated strong growth over the past 5 years. There are stocks like DexCom, Inc., which grew by 427 percent during the same period. This fund has invested more than 30 percent of its holdings only in two companies – Thermo Fisher Scientific Inc., and Abbott Laboratories. These two companies generated a return of 240 percent and 167 percent respectively.”

I am still quite optimistic that IHI’s significant holdings will be able to generate strong returns over a relatively longer period, say, within another six months or within a year.

Within the healthcare sector, only healthcare equipment and medical devices companies have been able to register price growth, whereas most companies belonging to pharmaceutical, managed healthcare, biotechnology, and life care tools & services have suffered huge price losses. An extremely poor one month has made the returns look ugly. But, if we keep aside the last four weeks, IHI’s price change over the past 12 months (19th April, 2021 to 14th April 2022) was almost nil, and the price moved within a range of $56 to $66.

People may think that a huge dividend cut from $0.0736 in Q4, 2021 to $0.0051 in Q1 2022, might be a reason for such a steep price fall. But, I don’t agree to this assumption, primarily due to its exceptionally low dividend yield. iShares U.S. Medical Devices ETF had a four year average yield of only 0.275 percent, which keeps income seeking investors at bay. In early March, I was quite optimistic about the future performance of this ETF. Though it suffered a setback in terms of price loss, I am still optimistic about this stock due to the growing demand for medical devices and healthcare equipment.

I am still holding the same opinion as last time that:

“as people are becoming more aware and healthcare agencies are placing more emphasis on early diagnosis and treatment of chronic diseases, the demand for such equipment will continue to grow. Moreover, the increase in geriatric population, added with growing prevalence of chronic diseases, will lead to significant growth in inpatient admissions, resulting in further demand for diagnostic and surgical procedures.”

However, in the coming few weeks, there is still scope for further downward price movement as indicated by the simple moving averages ((SMAs)). 200 days SMA (61.88) is almost four percent higher than the 100 days SMA (59.53). Again the 10 days SMA (53.42) is around eight percent lower than the 50 days SMA (58.16). The ETF is also trading very close to its 52-week low, and I won’t be surprised if it falls down lower than that before coming back to a long term growth trajectory.

Moreover, the price multiples are still higher than its peers or industry average, despite a 14 percent price drop from last time. On March 5th, Price/Equity (P/E) stood at 27.27, while Price/Book was 4.43. Price/Sales (P/S) was also high at 5.1. Eleven weeks later P/E (24.77), P/B (4.04), and P/S (4.62) are still quite higher. However, as I explained in my last coverage, due to IHI’s strong operating performance and cash flow growth, there is every possibility of this fund generating an above average growth in the medium and long term.

Thus, I’d prefer to hold back by investments in iShares U.S. Medical Devices ETF, and may buy further units if the price falls back further. However, as the price recovery of stocks from the healthcare sector is uncertain, I’d prefer to hedge my exposure through buying six months forward put options at a low premium on an exercise price somewhere around the current price. As the last traded price (premium) of $51 October 22 put options is quite low at $1.22, I’d like to hedge my existing exposures that were bought around a price of $60, so as to restrict my loss to a level of 15 percent.