What Healthcare Stocks’ Share Prices Imply about Future Growth, and How this Squares (or not) with Fundamentals

Richard

Hospitals are benefiting from rising patient flows and reduced costs for uncompensated care; however as insured patients move to cheaper forms of coverage they owe larger percentages of hospital bills, which they often don’t pay. Thus Hospitals’ net pricing is likely to come under further pressure as we lap the benefit of reducing the ranks of uninsured. Suppliers of Consumables to Hospitals enjoy all of the benefits of rising patient flows, but with more predictable pricing … yet many have share prices that imply slower growth than Hospitals (e.g. BCR, TFX, OMI; see pages 6-8)

Hospital employment fell at the beginning of 2014, and Hospital new construction spending is in outright decline. This implies Hospital administrators may have anticipated more demand growth from the Affordable Care Act (ACA) than has materialized. This further implies weak demand for companies that supply capacity-expanding (e.g. hospital beds) and capabilities-expanding (e.g. advanced imaging, robotic surgery) capital equipment to Hospitals. Inventories are rising at several of these firms, particularly EKTAY, HAE, ISRG, and VOLC (see pages 10-12)

Medicaid-predominant HMOs are gaining share in a rapidly growing (as hold-out states expand Medicaid) market, and average contract values stand to increase as higher-spend dual eligibles eventually are enrolled. In sharp contrast, Commercial-predominant HMOs stand to lose share (to local carriers) in a more gradually expanding market, and average contract values are stalling as enrollees choose cheaper forms of insurance. Nevertheless valuations fail to capture the difference in growth potential; we believe implied rates of growth for select Medicaid-predominant HMOs (particularly CNC, MOH, WCG) are far too low (see pages 13-14)

Demand for Dental products and services appears to be more elastic than demand for other healthcare products and services – meaning Dental demand should grow more quickly as employment grows and coverage expands. Despite this, Dental names (especially XRAY, PDCO) imply slower growth than the broader Healthcare universe (see pages 14-16)

The Dialysis providers (DVA, FME) are riding a more powerful demographic wave (obesity = type 2 diabetes = renal insufficiency) than the broader Healthcare universe, and stand to benefit from a sustainable expansion of gross margin once generic forms of erythropoiesis stimulating agents (ESA’s) are available (+/- 2016), yet share prices imply slower growth than for broader Healthcare (see pages 16-17)

For our full research notes, please visit our published research site

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