Looking for profits in eye care will pay off for investors

MoneyWeek magazine issue 943 cover story illustration – eye care

Vision care may not sound exciting, but it is an enormous market expanding quickly as ageing populations require more – and increasingly sophisticated – treatments, says Matthew Partridge.

The eyes may be the windows to our soul, but they are also a route to riches. Spectacles have been around since the late 13th century, and there are references to eye surgery in ancient texts. But we now spend more than ever before on seeing better. According to multinational opticians GrandVision, eyewear alone accounts for $130bn in spending, with further billions devoted to surgical devices, drugs and vision aids. With the overall market growing by 5% a year, any firm that can grab a slice of the action should flourish.

The vision care market will keep growing

There are three key factors powering the continued growth of the vision care industry. The first of these is demographics. People in the developed world are getting older, says Chris Elliott, a fund manager with Evenlode Investment, and with age the odds of “developing eyes issues increases”. It’s not simply a case of more people having eye problems either: the conditions people develop “tend to get more complex with age”. Indeed, “almost everyone will need some sort of vision assistance at some point in their lives”.

Meanwhile, the growth of the middle classes in emerging markets means that people outside Europe and North America now have large amounts of money to spend There has been a boom in vision care in developing countries, especially Asia and Latin America, because “people in those countries are getting better access to opticians, especially as the industry in those countries consolidates, with mom-and-pop operations being replaced by large chains”. People “are also becoming more aware of eye issues and are seeking out treatment for conditions, whereas previous generations would have previously accepted it as a normal part of life”.

We stare at screens too much

Changing lifestyles are also accelerating the speed at which people, in both rich and poor countries, develop eye problems, says Giovanni Abruzzini, Johnson and Johnson’s director for the northern Europe region. “Thanks to the increasing use of devices, such as mobile phones, and a decline in outdoor recreation (deemed important for strengthening the eyes), younger people are developing myopia – short-sightedness – at a much faster rate”. In particular, “there is a big myopia epidemic in Asia – eye problems are going to be a huge issue in the next few years”.

One country that has seen particularly rapid growth in lifestyle-related eye problems is China. The World Health Organisation estimates that 500 million people, roughly half the Chinese population, suffer from myopia. However, this may be an underestimate, with one medical study last year finding that nearly 90% of high-school students in Fenghua City, in Eastern China, are affected by the condition. Last August, President Xi promised that the government would take steps to improve eye health, with officials floating a wide range of policies, including an increase in outdoor activities in school, and restrictions on the online gaming industry.

Glasses dominate the market…

Most of the money spent on vision care goes on glasses. One reason for this is the way the industry is set up, with strong links between opticians and the companies that produce glasses. “When you go to opticians and receive a diagnosis of eye problems, you usually get a prescription for a set of glasses at the same time”, says Abruzzini. So, many people think glasses are the only solution and don’t consider other options.

Another factor that entrenches the dominance of glasses is the fact that many people “ just don’t like putting things in their eyes”. In addition to these people, who will be very hard to convince, there is a second group who, while theoretically open to the idea of contact lenses, are hesitant owing to a popular perception that wearing contact lenses dramatically increases the risk of eye infections, and that over time contact lenses can become uncomfortable.

… but contact lenses will catch up

While Abruzzini accepts that glasses are unlikely to lose their dominant position overnight, he’s confident that many people who currently wear glasses will eventually end up switching to contact lenses. This is due to the fact that the quality and convenience of contact lenses have dramatically improved, “with the current generation of lenses far better than they were even five years ago”. For example “contact lenses can now be worn during the entire working day”, while the switch from reusable (those taken out at night and reinserted in the morning) to disposable lenses “has reduced the risk of infection”.

“Many people also prefer contacts because glasses don’t suit them aesthetically”

There have also been major advances in the quality of materials used in contact lenses; we can now mimic glands found in the eye and eye tissue. Technological developments also mean that a far wider range of lenses can be produced. “We’re very close to a situation where each person can have their own bespoke lenses tailored to their individual conditions.” In the near future we should expect to see “contact lenses that can reduce glare and adjust to different types of light”. Older people should also benefit from the introduction of dynamic lenses that aid vision at different focal lengths.

Contact lenses have many advantages over glasses, says Ashleigh Hinde, founder of direct-to-consumer contact lens start-up, Waldo. Glasses are easily smashed, so those who play sports are better off with contacts. They can be worn with sunglasses or goggles. Vision through contact lenses “can often be better than glasses (especially for higher prescriptions)”. Many people also prefer contacts because “glasses don’t suit them aesthetically”.

A wide range of medical procedures

While glasses and contact lenses represent the bread and butter of the vision care industry, drugs and eye surgery are also important. The most common surgical procedure is cataract removal “due to the sheer number of people who develop problems with cataracts each year”, says Jean-Claude Dubacher, vice-president of surgical vision for Johnson and Johnson. What’s more, there have been some interesting developments in the past few years, such as the development of artificial monofocal lenses, which replace the patients’ own lenses that are removed during eye surgery. These meant that patients may be able to get away with only needing to wear reading glasses post-surgery; they typically require more than one pair of spectacles.

Surgical ophthalmology isn’t just about cataracts. It can involve treating a wide range of conditions in all parts of the eye. As well as treating glaucoma and retinal problems, surgery can address the root causes of many chronic conditions, rendering additional medication unnecessary. For example, although dry eye has traditionally been treated with daily drops, Johnson and Johnson has built a machine that can permanently solve the problem by unblocking glands in patients’ eyes. Another big area of growth is “spectacle independence surgery”, popularly known as Lasik, which allows many people to ditch their glasses entirely. It uses a laser to reshape the cornea, thus solving myopia and astigmatism. The procedure is not painful and usually takes around 15 minutes.

Still, Dubacher is confident that things are set to get even easier for those needing intervention. Indeed, “there is a rich pipeline of medical devices”. One particularly promising area is robotic surgery; robots already often carry out the first incision. They should make eye surgery more precise and the instruments less prone to tremors. While many of the discoveries will come from big firms “there are lots of vision-related start-ups, especially on the west coast of America, which are starting to offer a lot of new solutions to the question of how to make eye surgery even more successful”.

Of course, surgery isn’t the only way to improve people’s eyesight. Advances in drug therapy mean that chronic conditions such as high eye pressure can be contained much more easily, while the spread of some progressive degenerative conditions can be slowed. Stem cell therapy, especially the use of adult stem cells, has also raised the prospect of lost vision eventually being restored. For instance, researchers at the University of Newcastle recently published research suggesting that induced pluripotent stem cells (those that can self-replicate and become any type of human cell in the human body) could be used to heal the vision of acid attack victims.

Helping the blind see again

Glasses, contact lenses, surgery and drugs can do wonders for people’s vision. Yet some people are still left with severe visual impairments beyond the reach of current medical science, so they struggle to carry out basic tasks and live a normal life. The good news, however, is that technology companies are starting to develop devices that can compensate for these problems. For example, the Israeli company Orcam has developed a device, the Orcam MyEye, attached to glasses that can assist blind people in carrying out everyday tasks. The MyEye, which has a camera on one side and a speaker on the other, reads any printed material such as email, and can identify faces, money, and the colours of items.

“Snapchat has enjoyed modest success with its own glasses”

In the three years that the MyEye, which is now in its second generation, has been on the market, it has achieved “a high rate of customer satisfaction” claims Orcam’s founder Ziv Aviram. Some customers “even cry with relief after they realise that they are now able to do things like shopping, which they thought would now be impossible”. Having received regulatory approval, many insurance companies and health systems around the world now include the device in their coverage. While not yet available on the NHS, the British government has indicated that it may be willing to pay the cost of the device for those returning to work after an accident, as well as for visually impaired children (thus reducing the need for a reading assistant).

A vast potential market

While MyEye is primarily aimed at the 350 million people around the world who are blind or partially sighted, others could benefit too. “If you add in people with dyslexia and elderly people who suffer from reading fatigue (where reading requires so much effort that they quickly get tired) the potential market is more than one billion,” says Aviram. As the technology improves, it could even start to be useful for the able-bodied. For instance, “with the number of Facebook friends we have starting to exceed the human capacity to remember them, a future generation of the software could alert us when they are near us, and remind us of the last time we met them”.

Other companies are exploring the idea of smart glasses that appeal to a wider audience. Six years ago Google made headlines around the world when it started offering a prototype version of Google Glass, wearable voice-activated spectacles that people could use to browse the internet, record videos or take pictures. The video and camera functions ensured that the glasses generated more controversy than money owing to privacy concerns; people could be filmed and photographed surreptitiously. Google withdrew them from sale within two years. However, they have now made a comeback in the form of a version aimed at factory workers. The messaging firm Snapchat has enjoyed modest success with its own glasses.

One company betting big on smart glasses is the Chinese firm Huawei, which “expects to see a significant increase in the number of people who choose to wear smart glasses in the future and as consumer appetite for this technology increases”, according to a company spokesperson. Huawei predicts that the capabilities within these devices will evolve rapidly. It has therefore became the latest company to enter this market, recently announcing that it was launching its own pair of smart glasses in collaboration with Gentle Monster, a leading South Korean sunglasses brand. This is an exciting time for the wearables market and vision care in general. We look at how you can profit below.

The stocks to eye up now

The dominant player in the vision care industry is EssilorLuxottica (Paris: EL), formed as the result of the merger between Essilor, the leader in lens technology, and Luxottica, the largest producer of eyewear. The company owns several fashion brands, notably Oakley and Ray-Ban, and is the sector’s lowest-cost producer. It also owns several chains of opticians and has joint ventures with others, which further enhances its pricing power. While the company currently trades at 20 times 2020 earnings, strong growth prospects mean that this multiple looks justified.

Another company deeply involved in global eye care is Alcon (NYSE: ALC). Recently spun out of Swiss drug company Novartis, Alcon produces devices used in eye surgery, and is also one of the largest makers of contact lenses in the world. Its leading positions in both segments, and strong pipeline of products, should help it maintain strong sales growth. Ongoing cost cuts, through increased efficiency and cheaper manufacturing platforms, should also help it squeeze more profit from each product that it sells. The company’s management aims to triple free cash flow over the next five years. The stock is well worth a look despite trading on a 2020 price/earnings (p/e) ratio of 27.

Aerie Pharmaceuticals (Nasdaq: AERI) is a drug company that focuses on treatments related to eye conditions. Its main assets are two treatments, Rhopressa and Rocklatan, which both aim to lower eye pressure in those who suffer from glaucoma. Both drugs have recently been approved by the US Food and Drug Administration, and should be available in Europe and Japan shortly. This should enable the company to start making money, which it can reinvest in development of other drugs, including a steroid implant that has shown promise as a treatment for retinal problems.

GrandVision NV (Amsterdam: GVNV) is a chain of opticians based in the Netherlands. It operates in 40 different countries, getting nearly three-quarters of its revenue from outside Western Europe. It has had a strong track record of growth, with sales increasing by around 50% over the past six years. The fact that it has a global market share of only 4% means that it has plenty of room for further expansion. It also makes efficient use of its resources, as shown by its  impressive return on invested capital of 11.4%. It nonetheless trades at an extremely reasonable 16.8 times 2020 earnings.

Hoya (Tokyo: 7741) isn’t a pure play on vision care since it also manufactures optical equipment and electronic components for a wide variety of industrial, commercial and general medical use. Still, it gets around half its revenue from glasses and contact lenses, which means that it should benefit from the general growth in demand for these products. Gross margins of 85% on its products also mean that is able to make an impressive return on invested capital of around 18%. While it trades at 25 times current earnings, this is expected to fall to 21 by 2021.

Bausch Health Companies Inc (NYSE: BHC) was formed from the wreckage of Valeant, a pharma group hit by an accounting scandal in 2016. Having undergone a radical restructuring, which involved ditching non-core businesses, the company now receives half its revenue from its main subsidiary, eye-care company Bausch + Lomb. The new management has already taken steps to reduce its huge debt level, as well as renew its pipeline. The firm is expected to turn a profit this year after three years in the red. Despite its potential it trades at only six times 2020 earnings.