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US Healthcare Demand Slow for Cyclical (i.e. Temporary) Reasons; Volume-Sensitive Names are Undervalued

From 1960 to 2007 average per-capita ‘units’ and ‘mix’ of care (which we follow using an aggregate measure termed ‘elasticity/mix’) grew 2.2% (real, per-capita) annually, then fell 40bp each year from 2008 through 2011, reaching a 50-year low in 2010

Changes in per-capita elasticity/mix are starkly cyclical, and account for the entirety of the post-2007 fall in US healthcare demand. The fall in per-capita ‘units’ of care (e.g. physician visits & acute care admissions) appears to have been more important than any change in the ‘mix’ of care

Secular changes to per-capita demand (e.g. HDHP enrollment) are comparatively (and absolutely) small, explaining no more than one-eighth of the drop in per-capita elasticity/mix, and in all likelihood far less

As an almost entirely cyclical phenomenon, the (now trailing) trough in US healthcare demand presumably foreshadows a comparable recovery. Healthcare companies whose earnings are more sensitive to volume (cyclical) than either pricing power or new product flow (neither being cyclical) should see more substantial earnings acceleration in a recovery

Fundamental expectations and valuations for volume-sensitive healthcare names generally imply that a 50-year demand trough (2010) extends well into the future (+/- 2013). In effect these valuations signal a zero likelihood of improvement in the broader economy, a belief that the slowdown in healthcare demand is a secular ‘new normal’ or some combination thereof. Believing the healthcare slowdown is cyclical, and that broader economic conditions are as likely to improve as to deteriorate further, we see the volume-sensitive names as generally undervalued

Manufacturers / distributors of non-prescription consumables are most favored (e.g. BAX, BDX, COV), followed by commercial HMOs (e.g. UNH, WLP) and acute-care facilities (e.g. HCA, UHS, THC, HMA, LPNT, CYH). Because dental demand (both mix and volume) appears even more elastic than traditional medical demand, we see upside to manufacturers / distributors of dental consumables (e.g. PDCO, HSIC, XRAY, SIRO), though premium valuations make these names relatively less attractive

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