Editor’s Note: The following article is the April 2012 In Focus feature for CE’s sister letter Australian Edge.

Between 1999-00 and 2009-10, Australia’s spending on health care in real terms grew an average of 5.3 percent per year, from AUD72.2 billion to AUD121.4 billion.

During the same time average real growth in gross domestic product (GDP) was 3.1 percent per year–Australia’s GDP increased from AUD951 billion to AUD1,284.8 billion.

Total health care spending grew by AUD7.9 billion between 2008-09 and 2009-10, about 7 percent in nominal terms and 3.6 percent in real terms, or after adjusting for inflation.

Health care spending as a share of GDP has gone from 7.9 percent in 1999-00 to 9.4 percent in 2009-10. The AUD121.4 billion spent on health goods and services during 2009-10 averaged out to AUD5,479 per Australian.

Aging populations and the chronic conditions they increasingly live with support rising demand for health care over the long term, all over the developed world.

The strong industry fundamentals prevailing in the US, Canada and Europe are evident as well in Australia, where the first of the Baby Boomers have already turned 65, too, and during the past several decades the number and proportion of the Australian population that age and older has risen considerably.

Statistical data provided by the Australian Institute of Health and Welfare paint a compelling picture of a country grappling with the changing needs of a rapidly evolving population. But it’s doing it more efficiently than most, as Australia’s life expectancy at birth continues to rise and is among the highest in the world, almost 84 years for females and 79 years for males, and death rates are falling for many of its major health problems such as cancer, cardiovascular disease, chronic obstructive pulmonary disease, asthma and injuries.

In 2009 more than 2.9 million Australians (13.3 percent of the population) were aged 65 years or over, compared with just under 1.1 million (8.3 percent) in 1971. The increase in the population aged 85 years and over has been even more marked, with the number of people increasing more than five-fold over the same period.

But one of the consequences of living longer is living longer with chronic diseases. Very few people get into their 80s without one or more aspects of chronic disease, be it heart, diabetes, digestive issues and, increasingly, obesity. With all this comes an even more accelerated demand for health care.

Increased spending on public hospital services of AUD1.5 billion in real terms was the largest component of the overall increase in spending in 2009-10, accounting for just under a third (30.7 percent) of the increase, followed by spending on medications, which grew by AUD1 billion.

Total recurrent funding for medications increased by 6.8 percent between 2008-09 and 2009-10, just under the average growth of the previous seven years of 7.3 percent (2003-04 to 2009-10). A 7.5 percent growth in expenditure on benefit-paid pharmaceuticals between 2008-09 and 2009-10 strongly influenced this increase.

Health research was the area with the highest percentage growth in spending, 10.8 percent in real terms, although this is partly reflects the impact of a changed survey methodology employed by the Australian Bureau of Statistics (ABS). Dental services (largely made up of private providers) had the second-highest percentage growth in 2009-10, rising 7.5 percent.

As previously noted, spending on health accounted for 9.4 percent of GDP in 2009-10, an increase of 0.4 percentage points from 2008-09. Within Australia’s “universal” system, which comprises public and private components, governments funded 69.9 percent of total health expenditure during 2009-10, up from 69.3 percent in 2008-09 and 69.2 percent in 1999-00.

The federal government contributed 43.6 percent of total funding, while state, territory and local governments contributed 26.3 percent. Non-government funding sources provided the remaining 30.1 percent.

The Australian government’s share of public hospital funding was 39.7 percent in 2009-10, less than its 44.6 percent share in 1999-00 but an increase from 38.6 percent in 2006-07. State and territory governments’ share of public hospital expenditure was 50.6 percent in 2009-10, down from 51.2 percent in 2008-09.

The estimated national average level of recurrent expenditure on health was AUD5,251 per person in 2009-10.  The national average annual real growth per person over the period 1999-00 to 2009-10 was 3.9 percent, though this rate accelerated to 5.4 percent between 2004-05 and 2009-10.

According to Organization for Economic Cooperation and Development (OECD) definitions, Australia’s health expenditure as a proportion of GDP was 9.1 percent, which was 0.5 percentage points lower than the median in 2009 for member states. Australia spent a similar proportion of GDP on health as Slovak Republic, Finland, Italy, Spain and Ireland.

US health expenditure as a proportion of GDP in 2009 was the highest at 17.4 percent.

Government funding of health expenditure as a proportion of total health expenditure was 68.1 percent for Australia in 2009 compared to the median for OECD countries of 75 percent.

This solid fundamental foundation has held up Australian health care stocks over the past half-decade of tumult for markets around the world.

The S&P/ASX 200 Health Care Index posted a total return in US dollar terms of 50.8 percent from Mar. 30, 2007, to Mar. 30, 2012, while the S&P/ASX 200 Index was up 15.5 percent. The S&P 500, meanwhile, generated a total return of 10.5 percent during this time.

A recent flight to quality health has lifted the sub-index to a year-to-date total return in US dollar terms of 9.5 percent through Apr. 10, besting the S&P/ASX 200 Index (7.5 percent) and the S&P 500 (8.7 percent).

Costs are rising, though at a manageable level for the time being. Australia will face further pressure as the number of workers per health care benefit recipient shrinks, but the domestic economy is poised to benefit from broader global trends that should continue to provide upward support for standards of living Down Under.

Government has assumed a large burden, but it collects the revenue to cover it, the population seems happy with the system, with periodic changes at the margin hopefully presaging equally non-combative and satisfying legislative processes as demographic challenges grow bigger, and Australians are living longer, relatively healthier lives than most people.

Here are six companies trying to contribute to Australia’s and the world’s well-being.

A Domestic Sector with Global Significance

Australia’s health care companies are supported by demographic trends prevailing all over the developed world.  They also benefit from Australia’s “universal” health care system, which guarantees coverage to everyone through a combination of public and private mechanisms, taxes on the well off and subsidies for the less fortunate.

At the same time, too, several Australia-based health care companies have their foundations Down Under but are also taking advantage of opportunities in other developed markets. Some are expanding into emerging markets as well.

AE Portfolio Conservative Holding CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY), along with Aggressive Holding Newcrest Mining Corp Ltd (ASX: NCM, OTC: NMCGF, ADR: NCMGY), was one of the first two stocks to join the “Eight Income Wonders from Down Under” that formed the original Australian Edge Portfolio.

CSL has posted a total return of 17.3 percent in US dollar terms since Oct. 14, 2012. Newcrest, for its part, has shed 20.5 percent including dividends, making it the biggest loser measured from the issue date of recommendation in the AE Portfolio.

CSL, which researches, manufactures and markets plasma products and vaccines, is outperforming the S&P/ASX 200 Health Care Index (10.5 percent) and the S&P/ASX 200 Index (4.2 percent) handily during its holding period. The S&P 500, meanwhile, is up 12.2 percent, and the MSCI World Index has posted a total return of 7.5 percent.

CSL reported that fiscal 2012 first-half net profit after tax (NPAT) declined 3.4 percent because of pressures of a high Australian dollar. But management also lifted its full-year profit-growth guidance to 13 percent from 10 percent because of “vigorous” demand for its products.

Rising use of plasma-derived products, which raise antibody levels, and royalties earned from treatments such as Merck & Co’s (NYSE: MRK) Gardasil cervical-cancer vaccine helped mitigate the impact of a stronger Australian dollar, which is cutting the value of overseas sales.

NPAT for the six months ended Dec. 31, 2011, fell to AUD483 million from AUD500.2 million in the prior corresponding period, in line with expectations. On a constant currency basis, however, net profit grew 16 percent, as foreign currency swings impacted the bottom line to the tune of AUD95 million.

Revenue for the first half rose to AUD2.31 billion from AUD2.17 billion a year ago. Fees from licensing of intellectual property totaled AUD80 million, up 60 percent.

The Australian dollar strengthened by 6.3 percent against the US dollar during the 12 months to Dec. 31, 2011. The company will put in place “natural hedges” such as generating more expenses from its US operations to offset further such impact. North America was CSL’s biggest market, accounting for 42 percent of revenue, followed by Europe with 32 percent and Australia with 10 percent.

The company announced it will begin reporting results in US dollars from the financial year 2013, which will better reflect the dominance of that currency of the company’s worldwide sales and is in line with global industry practice. The company made a provision of about EUR11 million in the first half in case of delays or defaults in payments by southern European customers.

In a statement released along with the numbers CSL CEO Brian McNamee said, “We now anticipate profit will grow approximately 13 percent, using fiscal 2011 exchange rates, to around AUD1.06 billion, despite continuing economic pressures in Europe and the US and the return of a competitor to the market.”

CSL announced an interim dividend of AUD0.36 per share–up 2.9 percent from the prior corresponding period–payable Apr. 13, 2012, to shareholders of record as of Mar. 20, 2012. Management will declare its next dividend along with its fiscal 2012 final earnings announcement on Aug. 21, 2012.

CSL is a buy under USD35 on the Australian Securities Exchange (ASX) using the symbol CSL. It’s also a buy under USD35 on the US over-the-counter (OTC) market using the symbol CMXHF. This OTC-listed F-share (“F” is for “foreign”) is equal to one ASX-listed share.

CSL also trades as an unsponsored American Depositary Receipt on the US OTC market under the symbol CMXHY. The ADR is worth 0.5 ordinary share traded on the ASX. Buy CSL’s ADR under USD17.50.

Cochlear Ltd (ASX: COH, OTC: CHEOF, ADR: CHEOY), a newcomer to the AE How They Rate coverage universe, was an AUD83 stock a year ago. As of this writing it’s trading around AUD61.50, knocked down by a September 2011 voluntary recall of its key product, the Nucleus CI500 cochlear implant.

Management initiated the recall after “identifying a recent increase in the number of implant failures” due to a loss of “hermeticity.”

An internal investigation revealed that unexpected variations in the manufacturing process left a certain limited number of implants more susceptible to developing microcracks in subsequent manufacturing steps.

These microcracks allow water molecules to disrupt and eventually disable the implant’s electronic components.

According to management’s study of the problem the worst seems to have passed.

As of Jan. 31 the overall proportion of Nucleus CI500 series implants reported failed was 2.4 percent of registered devices globally; the number of newly reported device failures each month decreased in November, December and January. For the devices that failed the average time to failure after implantation was seven months. Of the 97.6 percent of devices that haven’t failed, more than 85 percent have been implanted for longer than the average time to failure.

Of the 2.4 percent that have failed, two-thirds were manufactured in the first quarter of 2011. More than 75 percent of the devices manufactured during this period that haven’t failed have been implanted for longer than the average time to failure of seven months.

Management reported on Feb. 7, 2012, that costs of the recall had been “fully quarantined.”

Now, a “cochlear implant” is a surgically secured electronic device that provides a sense of sound to a person who’s profoundly deaf or severely hard of hearing. A cochlear implant is often referred to as a “bionic ear.”

As of December 2010 approximately 219,000 people worldwide had received cochlear implants; in the US roughly 42,600 adults and 28,400 children are recipients. The vast majority of cochlear implant procedures are performed in developed countries due to the high cost of the device, surgery and post-implantation therapy. A small but growing segment of recipients have bilateral implants, or one in each cochlea.

Despite the challenges posed by the recall, Cochlear posted record fiscal 2012 first-half revenue of AUD387.5 million, an increase of 3 percent, with sales revenue rising 5 percent in constant currency terms. Headlines will record the statutory net loss of AUD20.4 million following AUD100.5 million in after-tax costs associated with the recall now fully expensed.

It also forms the basis of an official CEO statement on company results worth memorializing for its brevity and pointedness:

“While the AUD20 million loss was disappointing, the recall costs have been quarantined and importantly, a record number of recipients received a cochlear implant in the first half.

“Providing the gift of hearing remains our mission,” wrote CEO Dr. Chris Roberts, concluding his three-paragraph “Commentary.”

Cochlear implant sales, which includes accessories and sound processor upgrades, were AUD311.5 million during the period, up 1 percent on a reported basis and 7 percent in constant currency terms. Unit sales were 10,724, which is a decline of 9 percent from the first half of fiscal 2011. But it excludes more than 2,300 units that were shipped after the recall but were not recognized as revenue because they were offset against credit notes issued as part of remediation efforts.

Internal estimates suggest “the number of recipients receiving Nucleus cochlear implants for the half was at an all-time high.” Cochlear reported sales growth across all regions: Americas sales, though down 8 percent on a reported basis, were up 1 percent in constant terms to AUD149 million; Europe, the Middle East and Africa sales of AUD142.5 million were up 8 percent in constant terms, 4 percent on a reported basis; and Asia Pacific sales grew 11 percent on a constant basis to AUD59.7 million, 6 percent growth in reported terms.

Cash from operating activities of AUD67.4 million was down 26 percent versus the first half of fiscal 2011, while free cash flow was AUD70.8 million, not including recall cash costs of AUD12.1 million. Free cash flow a year ago was AUD67.3 million.

Total net debt as of Dec. 31, 2011, was AUD8.5 million, which equates to an operating net gearing ratio of 2 percent, defined as net debt as a percentage of net debt plus equity. Cochlear’s banking facility was boosted by AUD50 million to AUD200 million; as of Dec. 31, 2011, the unused portion of the facility was AUD107.2 million. Management paid down the facility by AUD27.7 million from Jun. 30, 2011.

Cochlear declared an interim dividend of AUD1.20 per share, paid Mar. 13, 2012, to shareholders of record Feb. 28, 2012, a 14.3 percent increase over the fiscal 2011 interim dividend.

Management hasn’t cut the payout in the last five years; in fact this last was the eighth increase over the past half-decade. The yield is a modest 3.9 percent at present, but the dividend rate is reliably growing.

Following the recall in September 2011 and as part of management’s rapid, thorough response Cochlear changed its manufacturing process to include a different electrode that provides equivalent performance to the compromised component. By December weekly implant production levels had surpassed pre-recall levels.

There’s no reason Cochlear won’t meet demand in the second half of the year. The fundamentals of its business remain strong, and Cochlear still has considerable flexibility to invest in long-term growth. That it still does in the aftermath of a substantial recall and a dividend increase is remarkable.

Cochlear has established itself as a market leader in niche that will grow along with developed world demographic trends. It has low debt, a low payout ratio and a track record of execution. The stock simply got crushed and hasn’t had time to recover as broader market sentiment has swung negative as it’s successfully coped with its issues. But herein lies opportunity.

Cochlear is a buy under USD66 on the ASX and the US OTC market using the symbol CHEOF.

Cochlear also trades as an unsponsored ADR on the US OTC market. Cochlear’s ADR–symbol CHEOY and worth 0.5 ordinary share traded on the ASX–is a buy under USD33.

Ramsey Health Care Ltd (ASX: RHC, OTC: RMSYF), Australia’s largest private hospital owner-operator, boosted its interim dividend by 13.3 percent. Ramsey hasn’t cut its dividend over the past five years–a period that encompasses what Aussies refer to as the “Great Financial Crisis,” more regularly, actually, as just the “GFC.”

Ramsey actually grew revenue by an average of 13.97 percent per year from fiscal 2007 through fiscal 2011, including a top growth rate during the period of 29.27 percent for the 12 months ended Jun. 30, 2008. From Jul. 1, 2008, to Jun. 30, 2009, during the worst of the GFC, Ramsey grew revenue from AUD2.651 billion to AUD3.165 billion, 19.38 percent amid the worst global economic conditions in 80 years. Strong operating cash flow is pacing a rapid reduction in leverage since fiscal 2005, a “taming” of what CEO Christopher Rex calls the “Ramsey snake.”

Ramsey is also a growing global company. It has 117 hospitals around the world, with around 10,000 beds, and employs approximately 30,000 people. Twenty-two thousand doctors are attached to its service, and Ramsey is approaching 3 million patient days per year.

Australia and Indonesia are the biggest revenue generators, though operations in Europe provide reliable revenue.

Ramsey reported a 5.7 percent increase in fiscal 2012 first-half revenue and other income from continuing operations to AUD1.972 billion over the prior corresponding period’s AUD1.866 billion. Core net profit after tax was AUD132 million, up 14 percent from a year ago. Group earnings before interest taxation, depreciation and amortization (EBITDA) was AUD299.8 million, up 10.3 percent from the first half of 2011, while group EBITDA margin improved by 62 basis points to 15.2 percent.

Australia and Indonesia revenue rose 7.6 percent to AUD1.59 billion, while earnings for the segment grew 15.3 percent to AUD201.2 million. UK revenue grew 0.5 percent to GBP176.8 million, while earnings were up 0.4 percent to GBP44.1 million. France generated revenue of EUR78.6 million, an increase of 16.6 percent, and income of EUR12.2 million, up 6.1 percent.

In Australia “means testing” of rebates offered to patients private health insurance will take effect Jul. 1, 2012. Impact is as of yet undetermined. Positive demographics continue to support Ramsey’s long-term growth, however, as approximately 50,000 Australians registered for private health insurance in the three months ended Dec. 31, 2011. As of that date 45.7 percent of the Australian population held private hospital treatment insurance.

UK margins remain strong despite the transition to “normal” tariff scenarios, buoyed by growth in the treatment of publicly funded patients. In France Ramsey is well placed to expand; revenue from the country now accounts for 5 percent of the group total.

Reported net profit after tax was AUD125.7 million, up 22.3 percent from AUD102.8 million a year ago.

Management renegotiated the company’s credit facility in November 2011, boosting it to AUD2 billion. The new facility is priced “competitively” on better terms for Ramsey than the one it replaced.

It comprises three- and five-year tranches, denominated in Australian dollars, UK pounds and euros. Management intends to draw the facility down on May 1, 2012. The company currently has “headroom” of about AUD600 million to AUD700 million to finance growth.

Ramsey, like other Australia health care stocks, has rallied hard since mid-March, as concern about a slowing China has dragged down sentiment Down Under and driven investors to more defensive sectors. But like the Australian health care sector, Ramsey has proven a solid long-term investment.

In order to accommodate the demands of an aging population with its walking-around diseases, Ramsey anticipates spending AUD100 million a year in brownfield development. In Australia recent experience suggests much close cooperation between private entities such as Ramsey and government to solve growing issues of health care delivery.

On the other side of the world, conditions in Europe will present a challenge. But management was confident enough to boost guidance for fiscal 2012 full-year results, to earnings growth of 13 percent to 15 percent from a prior range of 10 percent to 12 percent.

Because there isn’t a clearly identifiable fixed base for a private hospital operator–each patient, for example, has to be cared for according to his or her own diagnosis, which can vary widely and require different nursing capabilities, different feeding, etc.–management has to be efficient across many different categories to realize what margin improvements can be made. Ramsey has proven its ability to do this.

Ramsey Health Care is a buy under USD20.40 on the ASX and the US OTC market using the symbol RMSYF.

Sonic Healthcare Ltd (ASX: SHL, OTC: SKHCF, ADR: SKHCY) is a medical diagnostics company that furnishes pathology and radiology services to doctors, hospitals and other health care providers in the developed world.

Structured as “a decentralized federation” of diagnostic practices, the company’s head office is in Sydney, Australia. Sonic employs approximately 25,000 people in Australia, New Zealand, the UK, Germany, Switzerland, Belgium, Ireland and the US.

Concerned or angry about Obamacare in the US? Sonic management would have you ponder the possible upside, at least for its business, of an additional 30 million patients gaining health insurance and the testing and procedures it avails them.

Interim net profit for the half year to Dec. 31, 3011, of AUD143 million, equivalent to AUD146 million and an 8 percent increase in constant currency terms. Revenues across the companies operating segments were AUD1.642 billion, equivalent to AUD1.692 billion in constant terms, up 12 percent from the prior corresponding period.

Australian Pathology showed more signs that its turnaround is sustainable, posting segment revenue growth of 8 percent and 150 basis points of margin improvement. Sonic grew market share during the period despite opening proportionately fewer billing collection centers than competitors.

Pathology operations in Germany also posted impressive results, with margin growth exceeding 150 basis points. Organic revenue growth was better than management expected, as integration of past acquisitions continues to exceed expectations. This factor should also contribute to stronger second-half results as well.

As of its fiscal 2012 first-half conference call on Feb. 21, 2012, which was already about seven months into the full year, management noted that Sonic was on track to deliver EBITDA growth of 10 percent to 15 percent over the AUD570 million reported for fiscal 2011, in constant currency terms (applying 2011 average currency exchange rates to 2012).

Sonic CEO Dr. Colin Goldschmidt cited weakness of US laboratory operations due to a weak American economy. Sonic’s operations have fared better than competitors’, and results should also get a boost from an up-tick in doctor visits during the first quarter of 2011.

“Sonic’s operations continue to perform strongly, taking market share from competitors and increasing margins,” said Mr. Goldschmidt. Management’s effective integration of recent acquisitions, ongoing efforts to rein in costs and cautious financial management set it  up for further growth.

Management adjusted its forecast for net interest expense growth to 25 percent above the AUD65 million for fiscal 2011 from 30 percent; management now anticipates that underlying floating interest rates will remain unchanged during the second half of the year; the still-substantial increase is rooted in debt taken on in 2011 to fund growth.

Management declared a AUD0.24 per share interim dividend, which was paid Mar. 22, 2012, to shareholders of record as of Mar. 7, 2012. The next dividend–the final installment for fiscal 2012–will be declared on or about Aug. 20, 2012, when management reports results for the fiscal year ending Jun. 30, 2012. Sonic has maintained a conservative stance when it comes to dividend increases, holding steady with the recent interim declaration vis a vis the prior corresponding period and boosting a relatively modest 6.5 percent in total over the past five years.

Sonic Healthcare is a buy under USD12 on the ASX and the US OTC market using the symbol SKHCF. Sonic also trades as an unsponsored ADR on the US OTC market, under the symbol SKHCY.  Sonic’s ADR, worth one ASX-listed share, is a buy under USD12.

NIB Holdings Ltd (ASX: NHF, OTC: None) sells private health insurance to Australians, Australian students studying abroad and foreign students studying in Australia. The company reported a 12 percent increase in fiscal 2012 first-half premium revenue, and management boosted the dividend by 6.3 percent, despite the fact that it guided to the lower end of its AUD65 million to AUD70 million underwriting margin guidance.

Management has boosted the payout a total of 17.4 percent in the nearly three years since it first declared a dividend but is also responsible for the only dividend cut authored by an AE Health Care company during the Era of the GFC.

However, NIB is well-placed to grab market share in Australia’s private health insurance space. The stock doesn’t trade in the US, and it’s also priced well above its USD1.50 buy-under target as of this writing. If you trade on the ASX, NIB Holdings and its 5 percent-plus yield is a buy under USD1.50.

Auckland, New Zealand-based Fisher & Paykel Healthcare Corp Ltd (ASX: FPH, OTC: FSPKF) designs, manufactures and markets medical devices and systems for respiratory care, acute care and the treatment of obstructive sleep apnea. Its products are sold in over 120 countries globally.

The company generated 45.1 percent of its fiscal 2011 revenue in North America, 29.1 percent in Europe and 13.6 percent in Asia-Pacific; over the past two years sales in its home New Zealand market have declined 23 percent to account for just 11.9 percent of overall sales.

Fiscal 2012 first-half (ended Sept. 30, 2011) net profit after tax was NZD28.3 million, up from NZD16.9 million a year ago, as sales rose 3 percent to NZD252 million.

Fisher & Paykel will report fiscal 2012 (ended Mar. 31, 2012) final results on or about May 25, 2012. Management has guided to full-year net profit after tax of NZD67 million. In the meantime the stock is a hold.