China Sector Analysis: Health Care
Health Care is an expansive and multifaceted sector influenced by demographics, consumption, technology, and government policy. This is clearly evident in China, where the sector is increasingly driven by an aging population, changing consumer habits, digitalization, and greater private sector offerings. Although China’s health care sector only began privatizing in the 1990s, it is today a vast ecosystem hosting the world’s second largest pharmaceutical market. With China’s health care industry projected to be worth $2.4 trillion by 2030,1 its maturity from infancy will be tied to growing domestic demand and expanding its global reach.
As the next installment in an ongoing series that explores the 11 major economic sectors in China, this piece provides an in-depth look at the key stats, notable companies, and thematic tailwinds that characterize China’s Health Care sector, tracked by the Global X MSCI China Health Care ETF (CHIH).
While Health Care in the US is the second largest sector by market cap, it ranks eighth in China, suggesting that the sector is still early in its development. Compared to the US, many of the companies in this sector are part of complex organizational structures that have diversified business segments, creating deep vertical integration and overlap.2 At the industry level, Pharmaceuticals make up a larger part of this sector in China at around 55%, followed by Providers & Services at 14%, and Life Sciences Tools & Services at 13%.
Because of several thematic tailwinds discussed later in this piece, Analysts anticipate that China’s Health Care sector will experience higher sales growth versus the US. Yet despite higher growth expectations, valuations appear cheaper and debt levels lower for Chinese firms versus those in the US Health Care sector.
In terms of share types, the health care sector, as represented by the MSCI China Health Care 10/50 Index, is dominated by P Chips, which are companies operating in China, but listed in Hong Kong. Foreign investor access to onshore-listed A shares is set to increase over time as MSCI increases its A share inclusion factor over time.
American Depositary Receipts (ADRs) are stocks of Chinese companies listed on American stock exchanges. A Shares are listed on domestic stock exchanges in China and have been historically difficult to access. P Chips are stocks of companies operating in China, listed in Hong Kong, and incorporated in the Cayman or British Virgin Islands. Red Chips are stocks of companies based in China, incorporated abroad, and listed in Hong Kong. H Shares are stocks of companies incorporated in China and listed in Hong Kong.
Background on Health Care in China
China’s health insurance system more closely resembles Germany’s national social health insurance system than it does the US commercial health insurance approach. While China’s health care is supervised at the national level and guided by the principle that citizens are entitled to receive basic health care, local governments are ultimately responsible for funding and implementing these health services.
Given this local funding structure, and because of China’s Hoko system, which determines citizens eligibility for services according to birthplace, public coverage and quality varies widely from region to region. And because of budget constraints, public health insurance offers wide but shallow coverage for drugs and services, creating demand for private insurers to supplement public insurance regimes. Such deficiencies, along with a shortage of doctors and an increasingly health-conscious population have analysts projecting that China’s health insurance market could reach $193 billion in premium income by 2020.3
Health Care Industry Groups in China
While vertical integration is common in China’s health care sector, companies can be broadly classified into five major industry groups,4 including: 1) Pharmaceuticals; 2) Life Sciences Tools & Services and Biotechnology; 3) Health Care Supplies; 4) Health Care Technology; and 5) Health Care Providers & Services
- Pharmaceuticals: Pharmaceuticals is the largest segment, benefiting from global drug development rising to an all-time high. With over 15,000 drugs in the pipeline, drug development has grown at a 7.8% Compound Annual Growth Rate (CAGR) over the last 5 years.5 Local competition Is intensifying in anticipation of expanded subsidy programs and the approval of as many as 40 foreign drugs for domestic use. Although the development of generics has helped domestic pharmaceutical companies achieve scale, their growth will be dependent on their ability to complement or compete with life sciences and biotech firms that have taken advantage of China’s liberal regulatory environment to develop innovative treatments for complex diseases and cancers
SUB-INDUSTRY LEADERS: CSPC, SINO BIOPHARMACEUTICALS, CHINA RESOURCES
- Life Sciences Tools & Services and Biotechnology: Biopharma contract services include research and manufacturing companies (CROs and CMOs) supported by the R&D and manufacturing budgets of international pharmaceutical firms specializing in protein-based therapeutics. These firms attract international companies looking to reduce the cost of clinical trials and take advantage of China’s laxer regulations and higher production capacity. In 2018, over 22% of foreign biopharma firms report that China is their primary outsourcing priority and that over half of US biopharma companies are considering China as an outsource destination by 2023.6
SUB-INDUSTRY LEADERS: WUXI BIOLOGICS, GENSCRIPT BIOTECH, 3SBIO INC
- Health Care Equipment & Supplies: In this segment, generally large diversified firms look to compete on the production of equipment and consumables. The composition of China’s medical exports has shifted over the last 10 years from low-end consumables (i,e, disposable hospital supplies, first-aid kits, surgical gloves, and band-aids), to more technology-intensive products, including therapeutic and diagnostic devices.7 Fast-growth areas like equipment for in-vitro diagnostics are prioritized under China’s vision 2025 plan, which creates opportunities for local producers to potentially leapfrog older technologies to achieve faster scale and integration.
SUB-INDUSTRY LEADERS: SHANDONG WEIGAO
- Health Care Technology: Consumer companies like Alibaba have helped expand retail reach in China across segments with its e-commerce platforms. (Learn more about e-commerce here.) Online pharmacies like Alibaba’ are able to capture consumer demand, foster competition, make drugs and devices more affordable, and unlock economies of scale.
SUB-INDUSTRY LEADERS: ALIBABA HEALTH
- Health Care Providers & Services: Health care service providers provide health exams and consultations and assist patients in finding and scheduling appointments with the appropriate doctor or hospital. This industry also includes large pharmaceuticals’ subsidiaries focused on retail pharmacy, distribution, and logistics, which could increase competition and further integration across the Health Care Technology industry, as patients increasingly turn to virtual services and e-commerce.
SUB-INDUSTRY LEADERS: SINOPHARM, SHANGHAI PHARMACEUTICALS, HUADONG MEDICINE
For Top 10 Holdings for the fund please click here. Holdings are subject to change. Current and future holdings are subject to risk.
Long Term Tailwinds Supporting the Growth of the Health Care Sector
China’s Health Care sector is well-positioned to benefit from long term changes in demographics, consumption, technology, and government policy.
Demographics: By 2027, China’s senior citizen population will double, meaning 324 million Chinese will be over the age of 60.8 At the same time, China’s younger populations now have deeper pockets to cover the costs of specialized pharmaceuticals, biomedical devices, and services for its aging relatives, due to steadily rising wages and the lingering impact of China’s one child policy. Over the long-term, China’s growing wealth and aging population are expected to play a large role in powering the 10-15% health care growth estimates from analysts.9
Source: CSIS “Is China’s health care meeting the needs of its people?” as of Mar 14, 2019.
Increasing Expenditure: Health care expenditures in China have grown at a staggering 20% annualized rate since 2003, with 35% of all health care spending coming from out-of-pocket expenses.10 Yet health care spend represents just 8% of total consumption. By comparison, health care spend in the US represents over 22% of consumption expenditure. Analysts estimate that expenditures could reach $1 trillion as early as 2020, as China converges with developed market health care spending patterns.11 In doing so, it could more than double as a percentage of GDP, particularly as China’s seniors begin transferring their wealth to single-children and concentrating greater wealth within a more consumption-oriented generation.12
Changing Patients: Health care spending is partially related to greater demand for precision medicine and a greater frequency of diseases like myocardial infarction, stroke, pulmonary disease, lung cancer, and diabetes.13 But consumers are also demanding more personalized and higher quality health care to treat these ailments, reflected in the proliferation of private dental and pediatric clinics, greater availability of radio-, chemo- and gene-therapies, and the growth of online services, including doctor appointments and e-commerce solutions for insurance, devices, and drugs.
Low Penetration: While the government provides nearly universal health coverage for low-end services, private health insurance offers more comprehensive coverage. Yet private health insurance coverage remains in just the single-digits. Similarly, penetration rates for sophisticated services like radio-therapy remains in the teens. As China’s health care market continues to mature, the prevalence of private insurance, high end medical treatments, and even regular checkups are all expected to increase rapidly from their low bases.14
Technological Innovation: Companies like Alibaba, Tencent, and Sinopharm, are applying their technological expertise to Health Care by providing services like WeDoctor to optimize hospital management and device distribution and maintenance. Many health-tech efforts are AI-based to take advantage of China’s deep data pool with 1.4+ billion people and its laxer regulatory environment that encourages the advancements in AI. Focusing the country’s increasing technological prowess on the Health Care sector could unlock greater efficiencies, spark stronger demand, and reduce costs.
Outsourced Production: Increased demand for biologic drugs and therapies treating oncological or rare diseases, and the expansion of genetic engineering, specialized medicine, and clinical trials, have prompted many foreign firms to outsource development and production to China’s CROs and CMOs. In addition, certain multinational firms like Charles River Laboratories have invested aggressively in Chinese biotech firms and are shifting towards localized production models.15
Government Policy Support
Uneven access to health care resources, taken with rising incidences of chronic disease, widening coverage gaps, and a global technological arms race is prompting further government action to support the sector. Below are several steps authorities have taken to stimulate the growth of China’s health care system:
Improve Quality, Access, and Awareness: China has improved its health care access and quality, while making consumers more health conscious and likely to schedule regular doctor visits. In 2000, just 20% of Chinese had basic insurance coverage16 versus 98% in 2015 (albeit very basic).17 Although the Chinese have varied levels of health care, average healthy life expectancy (years of good health) has improved and is now higher in China than in the US.18 The government is seeking to further expand health coverage with Healthy China 2030, a policy that aims to bring clinics and hospitals to smaller cities and rural areas.
Support Health Care Innovation: China’s blueprint for the Greater Bay Area (GBA) seeks to integrate Hong Kong, Macau, and nine mainland cities within a Silicon Valley-like mega-region housing innovative start-ups and tech firms, including those in biotech. Government support for biotech over the last 20 years has resulted in the 22 life science parks in China, but GBA would build on CEPA, a free-trade agreement facilitating joint ventures with HK.19
Attract & Retain Talent: Given the increased demand for licensed practitioners, policy unveiled in March will allow hospitals to pay more competitive salaries. These efforts should help reduce labor shortages that force doctors to see 70-100 patients per day. By comparison, US doctors see an average of 30 patients per day. 20 GBA could also relieve overworked doctors with private practice and academic exchanges with Hong Kong.
Reduce Out-of-Pocket Costs: Government expenditure on healthcare is low relative to GDP, meaning local governments and individuals must often cover a substantial portion of the costs.21 Policies targeting out-of-pocket costs, which are a substantially larger portion of total health care costs in China than the US, were introduced in December 2018. Legislators introduced stimulus measures under the IIT (Individual Income Tax), cuts to VAT taxes and fees related to social security contributions and insurance. They have also implemented a pilot National Centralized Drug Procurement program to distribute and cap prices of over 31 generic drugs across more than 11 cities.22 Further, Beijing recently lowered postal fees for certain goods, including medicine, which will ease e-commerce distribution and promote price competition for generic and complex drugs and equipment.
International Drug Approvals: Approvals domestically and abroad have deepened the pharmaceuticals market. In 2018, the FDA and China’s national drug oversight agency (CFDA) approved record numbers of new drugs in 2018,23 benefitting Chinese CROs and CMOs with lower operating costs and competitive advantages in manufacturing. In 2015, the CFDA also revamped its procedural reforms to increase the pace and rigor of review, making China an attractive and competitive launching market for drug makers.
While China’s health care market is the second largest globally, its remains relatively immature, particularly when compared with developed market systems. Despite growing at double-digit rates for nearly two decades, health care expenditures still represent just 6% of GDP versus 17% in the US or 11% in Germany and France.24 As China’s population ages, wages rise, private health care services multiply, and technology advances, the growth trajectory of China’s health care sector is likely to command investor attention.
CHIH: The Global X MSCI China Health Care ETF seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI China Health Care 10/50 Index.