Healthcare holds broad investor appeal, with its diverse array of companies occupying different niches, global reach, and the ageing population all supportive of the sector.

However, valuations for Australian healthcare companies are at historically high levels--a result of their outperformance relative to global peers and the broader market in recent years.

"Looking at the whole sector, the PE premium is now close to 100 per cent relative to the broader market ... and there are a number of companies with PE multiples at, or near, their own 10- to 15-year highs," says Daniel Moore, senior equities analyst and portfolio manager, Investors Mutual.

He points to Cochlear (ASX: COH), Fisher & Paykel Healthcare (ASX: FPH) and ResMed (ASX: RMD) as examples of stocks in the sector he believes are trading at particularly high multiples of 40 times, 37 times and 28 times, respectively.

"The premiums for these larger stocks makes us less optimistic about the sector's returns in the near term but, as always, there are stocks that are offer value--it's just that they are now much harder to find," Moore says.

Australian healthcare companies regularly feature within Morningstar's Australia and New Zealand Best Stock Ideas, with three under its coverage rated as "Accumulate" by Morningstar equity analyst Chris Kallos. Each of these also hold a narrow moat rating.

Two of them are private hospital operators: Ramsay Health Care (ASX: RHC) and Healthscope (ASX: HSO).

Ramsay is the largest in this space, with a market capitalisation of more than $14 billion, 223 hospital and day surgeries, and more than 60,000 staff.

"We remain positive on Ramsay's move into community pharmacy, unveiled in fiscal 2016, and consider it complementary to acute treatment settings," Kallos says.

"We think the move increases the company's opportunity to engage with the patient by extending the company's reach into chronic disease management," he says, viewing the expanded service offering as particularly positive, "given age-related morbidities and the ageing of the Australian population".

With a recent closing price of $68.59, it trades at a substantial discount to Morningstar’s $87 fair value estimate.

Also holding a narrow moat, Healthscope is Australia's second-largest provider of private hospital services.

Kallos highlights ageing populations, advances in surgical and medical techniques, the government's continuing shift of medical service costs to the private sector and the outsourcing of public hospital management to private sector operators as key demand drivers.

Occupying a different segment of the healthcare space, Australian Pharmaceutical Industries (ASX: API) is the most vertically integrated of Australia's three national full-line pharma wholesalers.

Though Morningstar recently lowered its near-term earnings forecast for API by 2 per cent, "we retain our $2 per share fair value estimate," Kallos says.

He believes its medium-term introduction of new customer-engagement strategies, "an increasing focus on product offerings exclusive to Priceline, and the move away from heavily discounted categories ... towards colour cosmetics and skincare should be positive."

"Shares in API are trading at a significant discount to our valuation, and are therefore undervalued," Kallos says. The shares were trading at $1.38 at the time of publication.

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Glenn Freeman is a senior editor at Morningstar.

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