The brunt of U.S.-China trade tensions in the healthcare industry has fallen on life science tools companies, resulting in decreased product exports from the U.S. to China and uneven quarterly returns.
Pharmaceuticals and biotechnology, meanwhile, have largely escaped unscathed, thanks to China's increased demand for innovative medicines and explicit exclusion of therapeutics from tariffs.
Companies that sell instruments for small-molecule drug development and food and water safety testing have encountered additional roadblocks, as China cracks down on generic drug pricing and shuffles its government's food safety structure. These are both clear indications of China's potential economic slowdown, Danaher Corp. CEO Thomas Joyce Jr. said during a second quarter earnings call in July.
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"We're going to assume that the strain on the overall pharma market continues in China as well as food," Agilent Technologies Inc. CEO Michael McMullen said in May. "There is no recovery."
According to Cowen analyst Doug Schenkel, U.S. tools companies' exports to China fluctuate in tandem with the country's policies.
"China, obviously, is a dynamic market right now," Waters Corp. CEO Christopher O'Connell said on July 30.
Schenkel's July 19 and Aug. 5 notes, which compiled U.S.-to-China exports data from the U.S. Census Bureau's USA Trade Online database, revealed that the tools industry's 10% decline in second quarter exports to China was the "biggest single quarter decline in this dataset since at least 2013."
In 2013 and 2014, China's anti-corruption campaign and ministry reorganization led to a slowdown in the Chinese economy and consequent declines in U.S. companies' China revenue.
While tools giants Thermo Fisher Scientific Inc. and Danaher recorded growth in the first half of 2019, Schenkel warned that the industry's slowdown in exports may predict individual companies' declines in quarters to come, as was the case for Thermo Fisher, Agilent and Waters in 2013 and 2014.
"We acknowledge greater uncertainty due to the deteriorating macroeconomic data and potential unfavorable consequences to the global economy due to trade disputes," said Olivier Filliol, CEO of tools developer Mettler-Toledo International Inc.
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Overhangs in China
During recent second quarter earnings calls, executives said China's newly introduced generic drug pricing policy, known as the 4+7 initiative, ministry reorganization and consolidation of the government's food safety unit were points of weakness.
The U.S.-China trade war exacerbated the challenges, Agilent CFO Robert McMahon said.
The 4+7 program, introduced in late 2018, created a bidding process for drugmakers. Those who post the lowest price win a contract for that generic drug in a bulk procurement process.
"It really had a freeze effect in the market," Waters' O'Connell said. "Clearly 4+7 was a shock to the system in the first quarter."
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O'Connell added that Waters' food testing business, which is yet to recover from the recent policy changes, accounts for about 15% of the company's China division.
Agilent, which also has about 15% to 18% of its China business in food, said government labs have not resumed instrument purchases at the same rates as before.
"It's unclear right now what's going to be happening relative to China's desire to invest in the government labs," McMullen noted during Agilent's Aug. 13 third quarter earnings call.
Light at the end of the tunnel
Executives' caution varied across earnings calls, with all keeping an eye on trade tensions, but companies remained focused on the long game in China.
Overarching policy building out China's biotech industry and health, such as the Healthy China 2030 initiative aimed at health system reform and health equity, bodes well for life science tools developers, J.P. Morgan analyst Tycho Peterson said.
Despite adjusting full-year expectations for China revenue in 2019 down during second quarter and third quarter earnings calls, Agilent said China is "an important long-term growth market."
"Part of the story for 2020 is a return to an improved China market environment," McMullen said in May.
Even the 4+7 program could play out positively for tools developers with generic drugmaker customers, O'Connell said.
Peterson added that diagnostics will likely fuel growth for tools companies in China, which Danaher noted during its second quarter earnings call.
China has a $9.4 billion in vitro diagnostic market, Peterson wrote on Aug. 7, specifically pointing to disease detection tests using blood, urine and tissue samples.
"One of the real highlights in China is the continued, rapid emergence of biotechnology industry," Thermo Fisher CEO Marc Casper said July 24.
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