OVERVIEW
The healthcare sector comprises different industries, ranging from managed care organizations, healthcare facilities providers and medical devices manufacturers to biotech and pharmaceutical companies. Consequently, we believe that investors in this sector should be mindful of the different drivers and appropriate metrics associated with the various sub-sectors.
In the present scenario, investor sentiment in healthcare continues to be driven by decisions in the Congress related to government funding and the state of the broader economy. In view of the ongoing healthcare reform debate in the Congress, healthcare policy changes remain an important indicator to investing in the sector. The Health Bill intends to cover nearly all Americans by providing government subsidies to help pay premiums irrespective of health or income.
President Obama has made a last-ditch effort to revive the stalled U.S. healthcare overhaul with a plan to make insurance more affordable and to bolster government authority to regulate premium hikes. The plan, which aims to break an impasse in the U.S. Congress, intends to provide coverage to millions of uninsured Americans and set up federal monitoring of private insurers’ rate increases. The President’s proposal comes following months of debate on reform in the Senate and House of Representatives over their respective legislation.
As per the plan, health insurers would have to spend at least 80% of their premiums on medical care, a move that could result in penalties for 16% of health insurers. Furthermore, the proposed plan intends to penalize health insurers who spend more than 20% of premiums on operational costs, such as salaries and marketing.
Exorbitant rate hikes and profit margins became the subject of public debate after WellPoint Inc. (WLP) issued letters to the policyholders of its subsidiary Anthem Blue Cross in California, warning them of steep rate hikes.
Recently, the U.S. House of Representatives voted to strip health insurance companies of a 65-year-old antitrust exemption. The 406 to 19 vote aims to repeal an antitrust exemption that has meant that states take the lead in enforcing antitrust law for health insurers.
OPPORTUNITIES
We are positive on Health Net Inc. (HNT) on which we have an Outperform rating. While we remain concerned about the decline in membership, we believe a gradual improvement of the US economy should improve its membership status. Moreover, a strong balance sheet should enable it to tackle the current scenario.
Health technology holds the promise of improved operating efficiencies for many parts of the healthcare industry, hospitals included. However, in the short term those that stand to benefit the most from the stimulus are companies whose business models are based on information technology platforms.
One such company is BioScrip, Inc. (BIOS) on which we are positive despite its neutral rating. BioScrip is a specialty pharmacy services provider and pharmacy benefit manager. The company operates two interrelated business segments, namely: Specialty Services, which consists of specialty pharmacy distribution and clinical management services; and Traditional Pharmacy Services (previously referred to as PBM Services), which consists of pharmacy benefit management and traditional mail services.
The company’s diversified product mix across several key disease areas including immunology, multiple sclerosis and oncology should drive growth. The oral oncology business continues to show robust growth and should remain a strong part of the company’s business. We are pleased to see that the company is working on expanding its national reach and local presence and is adding infusion capacity in markets which have a large number of members.
We believe BioScrip is well-positioned to benefit from future healthcare reform initiatives like broader insurance coverage, the approval of a pathway for bio-similars and incentives supporting the utilization of information technology systems. The implementation of these initiatives is in line with the company’s strategy and should bode well for its future.
Another company on which we are positive — despite its current Neutral recommendation — is ZOLL Medical Corporation (ZOLL). We are pleased with the company’s wide range of products and significant international presence. The company has made multiple acquisitions in the past, which have aided growth and is looking out for more such opportunities.
The company is a leading player in the global market for external defibrillators, which is worth over $1 billion annually. ZOLL Medical has innovated a wide range of product features that have become the standard of care in the external defibrillator industry. The company is expanding its offerings to sustain growth.
WEAKNESSES
We recommend avoiding names like Molina Healthcare (MOH), on which we have an Underperform rating because of its declining profitability attributable to increasing medical costs due to the H1N1 influenza pandemic and costs associated with recently enrolled members. The impact of the pandemic is significant and has the potential to worsen in the coming quarters, affecting its profitability further.
Another company on which we are negative and have an Underperform rating is Aetna Inc. (AET), a diversified health care benefits company. Recently, the company delivered disappointing fourth quarter 2009 results. Aetna reported fourth quarter operating earnings per share (EPS) of 40 cents, missing the Zacks Consensus Estimate of 42 cents and was 58% lower than 96 cents reported in the year-ago quarter.
The primary reason for the decline was lower commercial underwriting margin, lower operating earnings in the Group Insurance business and an increase in pension expenses, partially offset by the lower number of outstanding shares. For full year 2009, operating EPS came in at $2.75, a 30% decline from last year.
The company is witnessing several headwinds such as rising unemployment, uncertainty related to healthcare reform and increasing cost pressure among others. Furthermore, intense competition facing the company is also a concern. Aetna competes with local and regional healthcare benefit plans in addition to large commercial health benefit insurance companies such as United Health (UNH) and WellPoint, among others, and Blue Cross/Blue Shield plans.
The outlook provided by the company for 2010 is not very bright either. Aetna projects full-year 2010 operating EPS in the range of $2.55 − $2.65, way below the Zacks Consensus Estimate of $2.86. Consequently, we advise investors to avoid the stock.
In general, health insurers are facing a drop in enrollment in their commercial segment. Insurers like Aetna Inc., Cigna Corp. (CI) and Humana Inc. (HUM) have resorted to job cuts to tide over difficult times.
