Ranked Preferences across Healthcare, Sub-Sector by Sub-Sector

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Suppliers of Commodity Consumables (e.g. BAX, BCR, BDX, COV, HSP, OMI, others ) and Labs (e.g. DGX, LH) are most preferred; both are levered to improving volume comps near-term and reform-related volume gains mid-term; Commodity Consumables in particular escape price pressures common elsewhere, and estimates / valuations appear especially low

Managed Care also is preferred; valuations imply excessive dis-intermediation and/or margin compression.  States need private insurers’ capital to expand coverage, and cannot set regulations as strict as valuations imply.  Margin pressures are non-trivial, but the excess of medical inflation over non-medical inflation is a substantial assist to margins, which valuations appear to ignore

Biotech offers select opportunities to outperform.  Concerns over private-market pricing freedoms and follow-on biologics appear overdone; conversely pricing risks from the Medicare Independent Payment Advisory Board (IPAB) may be under-appreciated, but can be mitigated by favoring names with low relative exposure to Medicare Parts A and B

Device Innovators (e.g. cardio and ortho) also offer select outperformance; we prefer cardio names with lower levels of export-market exposure (e.g. STJ, HTWR, THOR).  We expect stabilizing US average selling prices (ASP’s), and see pricing fears tied to hospital employment of surgeons as overdone.  Despite easing volume comps ortho names face headwinds as payors tighten eligibility standards; cardio devices also appear over-used, but are more difficult than ortho to restrict

We expect Generics to perform in-line with the broader healthcare indices. Despite being generally insulated from legislative / regulatory and competitive pressures that are common elsewhere, modest valuations, and pending patent expiries, we see little in the way of surprises, and note that expected patent expiries in the past do not appear to have driven share price outperformance

We expect mixed performance from Drug Manufacturers (traditional and specialty); modest relative performance v. broader healthcare indices may be available by focusing very narrowly on names with high ratios of pending product approvals to current sales.  Of the 22 names, 9 of the top 10 ratios of pending approvals to sales are in the specialty category

R&D Services are expected to underperform; sales expectations (8% growth through 2013) are too far ahead of R&D spending expectations (1% growth through 2013)

Hospitals are expected to underperform on under-appreciated collections pressures; the immediate trend to HDHP’s means a greater percent of private-market billings falls to insured beneficiaries’ co-pays and deductibles (with collection rates of 50%).  This trend accelerates when the exchanges begin operating, as beneficiaries purchase lower actuarial value policies, thus further increasing the percent of hospital billings that are the direct responsibility of consumers

The Drug Trades (Wholesalers, Drug Retail, PBMs) are expected to underperform on a series of issues, including deceleration of current rapid real pricing for branded drugs, erosion of generic dispensing margins, reduced absolute rebate totals as large brands lose patent; and, reduced incremental negotiating leverage as the market shifts to less-substitutable specialty brands, and as co-pay cards are increasingly used as an alternative to large rebates for preferred formulary status

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