Repel of Excise Tax on Medical Devices - FSMEX

bee

This area of business (Medical Devices) seems to have a natural moat (barrier to entry) that helps them weather market downturns, but these companies also are susceptible to litigation (law suits) since the stakes are high (an expensive life saving device should also carry a high standard of quality).

These devices were being taxed (starting in 2010) to help shore up the expansion of ACA (Affordable Care Act). That excise tax has been repealed. I am sure lobby efforts by these companies play a role in this change.

Stocks related to this tax repeal: JNJ, MDT, BAX, CAH, SYK, BDX, BSX, AGN, MMM, ABT, VAR, EW

FSMEX holds most of these companies.



Story via Seeking Alpha News feed (Source):

msf

Not to be too pedantic here, but isn't it a bit premature to say "That excise tax has been repealed"? I seem to recall a Rose Garden celebration when the ACA was similarly "repealed" by one house of Congress.

That's not to say that I don't expect the tax to be repealed. After all, its repeal has been supported in the past by the likes of Senators Elizabeth Warren, Al Franken, and Amy Klobuchar.

Aside from the old chestnut "buy on rumor, sell on news", how much impact would a repeal of a 2.3% tax, one that's already suspended until 2020, really have on company profits (and hence valuation)?

Medical device demand should be pretty inelastic. So the calculation may be simple - this could boost top line revenue by 2.3% (with tax revenue merely shifting to company revenue). With large medical device company profit margins in the 20-30% range, that's around a 10% increase in profits a couple of years down the road.

In the meantime, these companies are facing higher costs due to tariffs on steel and aluminum. Again, assuming inelastic demand, that's a significant hit, now, on profits.

Then there are the tariffs on medical devices imported from China (which seem to change month to month):

Several companies, including Medtronic and Zimmer Biomet, have orthopedic device factories in China that export goods to the United States. ... Any products shipped from those operations to the United States would be subject to the tariffs. Medtronic declined to comment, saying it was still reviewing the proposal. ...

By Friday [April 6, after the initial announcement on tariffs], the major medical device company stocks had dipped along with the overall market. Medtronic shares were 2.7 percent lower for the week, and Zimmer Biomet was down 2.4 percent.

https://www.nytimes.com/2018/04/06/health/trump-tariffs-china-devices-drugs.html

I doubt there were many people expecting the excise tax to ever go into effect again, so this is likely already priced in. Meanwhile, there are those tariffs. They're also likely priced in, though IMHO there's a lot more uncertainty with these - timing, magnitude, duration.

bee

Some thoughts:

Wouldn't the 2.3% be a bottom line cost savings on the product total cost?

Raw Material costs (from tariffs) would be an increased production expense if the device were manufactured in the US and usually a fraction of the final cost of the finished product. China does manufacture about 12% of US Medical device finished products that we import.

I haven't asked the question to my doctor, but I could imagine..."Hey Doc before we do this...where was my hip joint manufactured?" or "Hey, we have to re-schedule your operation...your hip is still on the ship."

From a April 2018 NYT's article:

The proposed tariffs have unsettled the medical device and supply industries, given that a growing number of products, as well as their components, are now manufactured in China. In recent years, as trade groups have noted, Chinese manufacturing of medical equipment has undergone a major shift from throwaway items like surgical gloves to more complicated products like magnetic resonance imaging scanners.

China’s medical device industry has been expanding rapidly. An International Trade Commission report in January said the fastest growth was in sales of implantable orthopedic devices, plates and screws, mostly made of titanium and used for surgery and sports medicine. One analyst estimates that about 12 percent of medical devices imported into the United States come from China

tariffs-china-devices-drugs

As for raw drug ingredient (coming from china) impacted by the tariffs:

...generic drugs that contain Chinese ingredients are manufactured in countries like India, meaning they would not be subject to the tariffs. And brand-name drugs made in the United States are frequently so expensive that the list price often has little connection to the product’s manufacturing cost.

Passing costs on or padding costs may also at play here:

“The cynic in me thinks this is another way for companies to say they need to raise their prices,”

msf

You're quoting from the same NY Times article as I did. Brilliant minds think alike

Since you raised the issue of medical devices, I ignored the section on drugs. China doesn't export many drugs to the US. Right about now, it looks like there's a very good reason for that.
https://www.theatlantic.com/science/archive/2018/07/chinas-vaccine-scandal/565943/

Top line vs. bottom line - My understanding (see, e.g. the Brookings link I provided above) is that the tax was treated as a sales tax. To me that means the customer pays it. Assuming the customers continue to buy the same number of devices and pay the same total amount (including sales tax), then the manufacturers' revenue increases as that 2.3% is now received by the company instead of the government. Since the manufacturers are not the ones paying the tax, their costs are not affected.

This differs from the Cadillac tax, where (again as I understand it), the tax is on the insurers providing the policies. Of course they pass that expense through, just as they pass their administrative costs and other costs through. There, I'd say that eliminating the Cadillac tax would reduce insurers' expenses (as opposed to increase their revenues).

Is there a CPA in the house?