Hospitals’ Stable to Improving Net Pricing Power

Richard

Hospitals trade at a 30+% discount (’13 PE forward) to cap-weighted Healthcare and the SP500; fundamental concerns appear centered on a combination of weak volume / procedure mix, and the effect of Budget Control Act (BCA) related Medicare rate cuts in 2013

US healthcare demand has slowed for almost entirely cyclical reasons; 2010 was a 50-year low for the cyclical components of demand (per-capita ‘units’ and ‘mix’). Improvements to volume and mix are more likely than either continuation of the 50-year low or further declines; this augurs well for volume-sensitive healthcare sub-sectors generally, and hospitals specifically

In addition to poor volume / mix, hospital valuations imply weak pricing; in contrast we believe the aggregate price trend across all payors (Medicare, Medicaid, commercial) is at least stable, and in fact may improve

Hospitals have rising commercial pricing power as 2014 approaches; assuming the Affordable Care Act (ACA) remains reasonably intact, health plans hoping to participate in 2014’s enrollment gains need premier hospitals in their networks more than they need to control these hospitals’ prices. 2014’s marginal enrollees are likely to have been un- or under-insured beforehand, and so are unlikely to be familiar with local health plans. These same potential enrollees are likely to be very familiar with higher-profile local hospitals; and the presence or absence of preferred hospitals should have a large effect on which plans new enrollees choos

This dynamic appears to have played out during Massachusetts’ ’07 – ’09 reform-related enrollment expansion; across this period MA teaching hospitals had greater margin gains than both their smaller MA peers specifically, and the nation’s hospitals more generally

We believe hospitals as a group are undervalued, and their near-term fundamentals underestimated; accordingly we believe the group should outperform the broader healthcare index. The primary risk to our call is that the Supreme Court dismantles ACA sufficiently to reduce the likelihood of 2014 enrollment gains, thus reducing hospitals’ commercial pricing power, not to mention the adverse effect this would have on longer-term expectations regarding both patient volumes and uncompensated care

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