Accelerating Growth in Hospitals’, Physicians’ Offices and Other Care Settings’ Labor Hours Signals Improving Healthcare Demand

Reported earnings are a surprisingly weak indicator of near-term changes in healthcare demand; the dominant settings of care (hospitals, physicians’ offices) are vastly under-sampled

In contrast, monthly aggregate labor hours offer a timely and broad-based sample of activity in hospitals and physicians‟ offices; and, because these settings do not produce inventory, labor hours (as a proxy for supply of care) are a useful coincident indicator of healthcare demand

In settings of care broadly, and in hospitals and physicians’ offices specifically, aggregate labor hours have recently begun growing at an accelerating rate, a strong indication of improving healthcare demand

Nevertheless volume-sensitive sub-sectors, in particular hospitals and non-Rx consumables, imply a continuation of trailing demand levels; this despite 2010 having been a 50-year low in per-capita demand, that these sub-sectors are substantially more volume-levered than their healthcare peers, and that healthcare demand appears to be accelerating

We continue to believe hospitals (e.g. HCA, UHS, THC, HMA, LPNT, CYH) are generally undervalued, as are non-Rx consumables (e.g. BAX, COV, BDX, BCR, CFN)

Despite evidence of rising utilization, we also continue to see the commercial HMOs (e.g. UNH, WLP, CI, AET) as undervalued. Because cyclical utilization gains correspond with employment gains, HMOs’ enrollment grows, and marginal enrollees tend to be considerably healthier than legacy enrollees. Where current valuations imply margin compression, we believe HMOs can expect both steady gross margin and expanding enrollment

Because we cannot handicap the outcome of the pending Supreme Court decision on the constitutionality of the individual mandate, and because we view most decisions relating to the mandate as having opposite effects on the earnings power of Hospitals and HMOs, we recommend holding both of these sub-sectors against one another across the (late June / early July) Supreme Court decision