Is There a Cyclical Rebound in US Healthcare Demand? Evidence to Date from 1Q12 Results

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Richard Evans / Scott Hinds / Ryan Baum

203.901.1631 /.1632 / .1627

richard@ / hinds@ /

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May 2, 2012

Is There a Cyclical Rebound in US Healthcare Demand? Evidence to Date from 1Q12 Results

  • The link between quarterly reports and underlying healthcare demand is remarkably noisy and signals from 1Q12 results thus far are mixed; however on net we see convincing evidence of strengthening US healthcare demand
  • With a single exception (HUM) commercial payors saw rising 1Q12 utilization; Hospitals’ adjusted admissions are accelerating; and, US demand for knees is showing strength across all suppliers
  • Distributors’ 1Q12 US sales generally accelerated, though a significant portion of this may be due to market share gains by these distributors’ large customers
  • Dental demand is perhaps the most elastic, thus we tend to view the dental stocks as canaries; Dentsply (XRAY) reported its best rate of internal growth since before the recession, with double-digit US growth offsetting cyclically weak EU demand
  • Despite these results, and also despite strength in non-disclosure related concurrent indicators of US healthcare demand (e.g. aggregate hours worked in healthcare settings), revenue estimates and share prices for the more volume-sensitive healthcare names imply a multi-year continuation of trailing demand levels, which we’re convinced were cyclical lows
  • We recommend a pro-cyclical / pro-US tilt to healthcare portfolios; our favorites are Hospitals, Non-Rx Consumables (e.g. BCR, BDX, BAX, COV, HSP, OMI, CFN), and commercial HMOs (e.g. WLP, UNH, CI, AET)


1Q12 results thus far are mixed, but on net point to improving US healthcare demand off of what we believe was a cyclical trough. Taken in aggregate these results are consistent with concurrent indicators such as aggregate hours worked in healthcare settings, which are also improving off of cyclical lows

Despite growing evidence of a cyclical healthcare demand recovery, estimates for more volume-sensitive names continue to imply a continuation of weak demand (at very near cyclical trough levels), as do share prices; thus we see opportunity in the more volume-sensitive healthcare sub-sectors

We continue to favor a pro-cyclical (and pro-US) tilt to healthcare portfolios; in particular we favor Hospitals, Non-Rx Consumables, and Commercial HMOs[1]

Background and caveats

We believe cyclical factors are the dominant cause of low trailing US healthcare demand[2]; and, that concurrent indicators such as aggregate hours worked in healthcare settings signal that demand is improving off of a cyclical trough[3]

Estimating underlying healthcare demand via an aggregation of quarterly disclosures is tricky at best; care settings (hospitals, physicians’ offices) are either under-sampled or not really sampled at all; and, manufacturers’ and distributors’ businesses all face large idiosyncratic risks, making it impossible to reliably separate stock-specific and industry-wide demand trends. 1Q12’s additional calendar day and considerably weaker flu season complicate matters further[4]

With these considerable limitations in mind, we offer our read-through of the underlying US demand trend based on 1Q12 results thus far. On net we believe the quarterly results point to improving demand

Brief summary of US demand signals by sub-sector and company

Payors – 3 up, 1 down

WLP (13.9% of US commercial enrollment) was mildly positive on the US demand trend, suggesting ’12 demand was improving, though at the anticipated rate

UNH (7.5% of US commercial enrollment) pointed very clearly to a modest increase in utilization during 1Q12

AET (3.2% of US commercial enrollment) pointed to a rising demand trend, in particular a shift from a trailing < 5.5% (nominal) ’11 trend to a 6.5% +/- 50bp expectation for ’12. The company referenced its prior authorizations data as indicating strengthening demand

HUM (1.1% of US commercial enrollment) was the outlier; the company saw weakness in utilization, particularly inpatient admissions, and lowered its US medical trend estimate to the low end of its 6.0% to 6.5% (nominal) guidance

Hospitals – accelerating (flu-adjusted) admissions

CYH (2.4% of US licensed beds) beat its own 1Q12 forecast; adjusted[5] same-store admissions increased 2.5% versus prior year; in 1Q11 adjusted admissions were flat v. 1Q10. The company estimated that weaker flu in 1Q12 reduced admissions growth by 1.8%

UHS (2.4% of US licensed beds) reported same-store adjusted[6] admissions growth of 1.6%; the year prior trend was 0.6%

HMA (1.1% of US licensed beds) estimated same-store adjusted[7] admissions, including an adjustment for flu, were up 2.4%; the prior year trend was 0.5%

LPNT (0.7% of US licensed beds) disclosed improving surgical volumes and expressed confidence in achieving guidance at the high end of its range. The company pointed to increasing acuity, and improvement in cardiology, imaging, and oncology. Adjusted[8] same-store adjusted admissions were down 40bp v. prior year before accounting for the weaker 1Q12 flu season; the company estimates flu reduced 1Q12 growth by 1.5 – 2.0%

Distributors – accelerating US growth; cannot entirely separate systemic demand from customers’ share gains

ABC ($80B annual US revenues) reported that its largest hospital customers grew significantly in the quarter, and that this created a volume trend that was slightly higher than had been expected

MCK ($102B annual US revenues) also saw growth from its largest customers, though much of this was attributed to these customers’ share gains. Nevertheless the company did characterize the strength of 1Q12 warehouse sales as surprising

OMI ($9B annual US revenues) saw net revenue gains of 4.4%, attributing most (2.6%) of this to sales gains from existing customers. However OMI attributed this growth to acquisitions by these customers, rather than any clear evidence of improvement in underlying demand

Manufacturers – Surge in knees, dental

ZMH (26% share of US knees) reported a 400bp sequential improvement in US unit demand for knees, and qualitatively suggested that hip demand is on a similar trend

JNJ (24% share of US knees) mirrored ZMH’s comments with respect to accelerating demand for knees

In contrast SYK (21% of US knees) was decidedly neutral, characterizing the environment as ‘stable’, and conveying no evident uptick in utilization

COV ($6B annual US revenues) was decidedly neutral on the demand trend; sales came in ahead of plan, but the company attributed the result entirely to share gains

BCR ($2B annual US revenues) also was neutral, claiming little or no change in the US demand trend

XRAY ($900M US annual sales of dental products) characterized 1Q12 as its strongest quarter since before the recession; strengthening double-digit US demand growth was sufficient to more than offset cyclically weak EU demand

Laboratories – No change

DGX (150M annual tests) was negative, pointing to audit data of a 2% year-on-year drop in physician office visits; however DGX made no indication that their figures were adjusted for the weaker flu season

LH (124M annual tests) was neutral on the demand trend, pointing to steady 1% unit growth rather than any re-acceleration; LH also made no indication that figures were adjusted for the weaker flu season

Estimates and share prices

Revenue growth estimates for the remainder of 2012 have improved marginally for the more volume-sensitive names since the release of 4Q11 results (Exhibit 1), while revenue estimates for the less volume-sensitive names have fallen marginally. Extending the forecast period through 2014, longer term revenue growth estimates for the more volume-sensitive names also have risen faster than for less volume-sensitive names (Exhibit 2). Nevertheless despite these (small) positive revisions, revenue growth estimates for the more volume-sensitive names continue to imply forward growth rates that are only marginally higher than the trailing cyclical trough (Exhibit 3) – which we believe was an all-time (at least 51 year) low in US per-capita ‘unit’ demand for healthcare[9]. Revenue multiples for the more volume-sensitive names remain static (and low, Exhibit 4) despite mounting evidence of a cyclical recovery. All in, this argues that the market is pricing in a continuation of near cyclical lows, despite strong evidence of cyclical improvement; accordingly we recommend tilting portfolios toward more volume-sensitive (and more US-focused) names; in particular we favor Hospitals, Non-Rx Consumables (e.g. BCR, BDX, BAX, COV, HSP, OMI, CFN), and commercial HMOs (e.g. WLP, UNH, CI, AET)

  1. We appreciate it seems odd to recommend HMOs on rising utilization. However believing the current demand trend only will improve as the economy improves, we see employment (and thus commercial enrollments) rising alongside utilization. A rising enrollment trend more than offsets the negative earnings effects of higher per-capita utilization
  2. Please see “US Healthcare Demand Slow for Cyclical (i.e. Temporary) Reasons, January 12, 2012, SSR
  3. Please see “Accelerating Growth in Hospitals’, Physicians’ Offices and Other Care Settings’ Labor Hours”, March 12, 2012, SSR; and “Healthcare Demand is (Cyclically) Improving Ahead of Estimates and Share Prices”, April 16, 2012, SSR
  4. Flu-related demand appears to have been roughly twice as strong in 1Q11 as in 1Q12. Using flu tests as an indicator of the number of patients presenting with flu-like symptoms, nearly 140,000 patients were tested in 1Q11, v. just more than 78,000 in 1Q12. There were more than 41,000 positive tests in 1Q11, v. just fewer than 14,000 in 1Q12. CYH stated 1Q12 adjusted admits were reduced approximately 1.8% by the weaker flu season; LPNT offered a comparable range of 1.5 to 2%
  5. Adjusted for inpatient / outpatient mix
  6. Ibid 5
  7. Ibid 5
  8. Ibid 5
  9. Ibid 2
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