Health Care — It's Complicated

6/5/2017


It's now the Republicans' turn to take on the unpopular role of trying to contain U.S. health-care costs. This spring, the House of Representatives approved the American Health Care Act, which would replace the Democrats' 2010 Affordable Care Act.

The Congressional Budget Office estimates that the latest Republican plan would cause 23 million people to lose their insurance over the next decade, while saving the government $119 billion. The Republicans' original plan would have reduced the ranks of the insured by 24 million, said the CBO, and slashed $337 billion from the deficit over that same period.

Under ACA, the ranks of the uninsured dropped to 11%, versus 15% in 2008, as about 12 million people gained access to Medicaid coverage in 31 states. Medicaid now accounts for about 17% of health spending, up from 15% in 2005 and 10% in 1990. The House proposal would cut federal funding for Medicaid, likely forcing states to reverse their expansion in the next few years. The plan would also crimp funding for hospitals.

The House Republicans' new bill includes tweaks to their original proposal. This plan would let insurers charge higher premiums on people with pre-existing conditions who let their insurance lapse. It would also give the states the option to allow insurers to sell plans with less comprehensive coverage, stripping out maternity care and prescription drugs.

Under the latest plan, insurance premiums are expected to climb 20% next year and 5% in 2019, though unhealthy people could face hikes sharply higher than those estimates. Healthier patients would enjoy lower premiums but could see higher out-of-pocket expenses due to less comprehensive coverage.

The bill is widely unpopular in polls, compelling Senate Republicans to pledge to draft their own version. But senators are divided between those wanting to reduce the number of uninsured and those determined to further cut back on health care. They also disagree over the prospect of keeping the ACA's Medicaid expansion. To pass any bill, Republicans can only afford to lose two Senate votes. Senate Majority leader Mitch McConnell recently said, "I don't know how we get to 50 (votes)." Some senators hope to complete their plan by August.

Hospitals, insurers, and doctors all oppose the House plan. Yet the latest CBO report had little effect on shares of companies most affected by the bill: hospitals and insurers with large Medicaid businesses, such as Centene ($73; CNC). In fact, health-care stocks of all stripes have performed fairly well since the Nov. 8 election. All 10 industries have averaged total returns of at least 10%, and the sector's average return of 20% has outpaced the index's 14%.

S&P 1500 HEALTH-CARE BREAKDOWN
-- P/E Ratio --
12-Mo. Change
Est. EPS
Change,
Current
Fiscal Yr.
(%)
Total Return
Industry
(Number Of Companies)
Trailing
Curr.
Year
Earnings
Per
Share
(%)
Revenue
Per
Share
(%)
Since
Nov. 8
(%)

Past 12
Months
(%)

Quadrix
Overall
Score
Distributors (8)
19
16
(10)
(10)
(1)
11
(3)
56
Equipment (38)
34
28
13
13
10
22
31
54
Facilities (13)
23
18
0
0
8
14
(10)
56
Services (18)
26
22
5
5
1
23
18
61
Supplies (13)
36
32
17
17
5
30
89
58
Technology (8)
45
28
(19)
(19)
3
22
16
43
Managed care (10)
25
24
24
24
15
26
35
81
Biotechnology (24)
21
24
(8)
(8)
6
15
10
57
Life-sciences
tools  (14)
33
28
3
3
9
24
23
59
Pharmaceuticals (27)
24
18
1
1
(3)
12
6
55
S&P 1500 health-
care sector average
29
24
5
5
5
20
21
57
20-year average
25
20
10
12
17
60
S&P 1500 Index
average
24
22
5
5
6
14
19
59
20-year average
22
19
7
7
14
58
Notes: We calculated a 10-year average — not 20-year average — for current-year P/E ratio due to lack of historical data. Averages exclude P/E ratios above 75 or below zero, and growth rates above 75 or below -75. Quadrix scores are percentile ranks, with 100 the best.

Below we review all four of our recommended health stocks: two drugmakers, a managed-card provider, and a services company.

Shares of Amgen ($155; AMGN) and other drugmakers seem to faint every time politicians and patient groups rail against escalating drug prices. The new chief of the Food and Drug Administration has also taken up the cause by proposing to quicken the pace of generic drugs reaching the market. Fortunately, Amgen has relied on higher volumes, rather than price hikes, to drive recent growth, especially for its newer drugs. Management expects minimally higher net selling prices this year and says its long-term growth strategy centers on boosting volumes.

Amgen is generating solid operating momentum for earnings per share (up 11% for the 12 months ended March), operating cash flow (12%), and free cash flow (8%). But slowing growth for several older drugs is putting more pressure on the pipeline to produce new products. That pipeline is having mixed success. A recent trial raised unexpected safety concerns for an experimental osteoporosis treatment, likely forcing Amgen to postpone filing for approval this year. However, Amgen plans to seek regulatory approval later this quarter for a potential blockbuster drug that combats migraines. Amgen is a Buy and a Long-Term Buy.


Recent growth for Celgene ($114; CELG), like Amgen, has primarily come from higher volumes (up 15% in the March quarter) rather than higher prices (up 3%). Since its latest quarter report, Celgene has seen its analyst profit estimates rise for both the June quarter, implying 24% growth, and 2017, 23% growth. Celgene has grown sales more than 10% in 57 straight quarters, a streak likely to extend into 2018. Shares trade at 18 times trailing earnings, well below the average of 24 for S&P 1500 biotechnology stocks. Celgene's trailing P/E ratio lingers near historic lows for the stock.

Although shares are up 5% since the Nov. 8 election, they have flatlined in 2017. But there's no shortage of catalysts that could revive the stock price and keep its remarkable track record for operating growth intact. With a pipeline packed with potential new products, Celgene expects to receive results for 18 late-stage trials by the end of 2018. Celgene is a Focus List Buy and a Long-Term Buy.


Few companies are more exposed to the repeal of the Affordable Care Act than Centene ($73; CNC). About 20% of its profits come from the ACA exchanges and Medicaid expansion populations; both end markets face potential funding cuts by Republicans that could go into effect by 2020. Centene's Medicaid membership has more than doubled since the ACA's 2014 introduction and now represents about 60% of its medical members.

With Republicans sharply divided over the government's fundamental role in health care, passage of a replacement law is far from certain. Reflecting that skepticism, Centene shares have surged 29% in 2017, racing out ahead of the S&P 500 Index's 8% gain. Yet the stock's valuation still looks enticing at 15 times estimated 2017 profits, versus an average of 22 for the S&P 1500 health-care sector and 24 for managed-care stocks. Centene earns the maximum Quadrix score of 100. With a leading 13% share of the Medicaid market, Centene is a Focus List Buy and a Long-Term Buy.


Laboratory Corp. of America ($139; LH) earns an Overall score of just 69, hurt by poor ranks for Momentum (39) and Earnings Estimates (18). The legacy lab-testing business (about 70% of sales) continues to perform well, and management says the contract research organization (CRO) industry remains healthy. However, the slowing conversion rate for its CRO backlog forced management to cut its 2017 forecast in April. The CRO business (30% of sales) tests developmental drugs.

Analyst estimates are trending down, though even the most pessimistic targets call for decent 2017 growth of 6% for per-share profits and 4% for revenue. The stock has a trailing P/E ratio of 16, while S&P 1500 health-services stocks have a median of 22. If LabCorp's P/E returns to its own five-year median of 17 and the company meets the most bearish profit estimate of $9.35 per share, the stock will rally 14% over the next eight months. The shares are up 8% so far this year. LabCorp is a Long-Term Buy.

TOP HEALTH-CARE STOCKS
Our A-rated (above-average) health stocks are listed below. Stocks recommended for purchase are in bold.
-- P/E Ratio --
12-Mo. Growth
Est. EPS
Change,
Current
Fiscal Yr.
(%)
Total Return
---------------- Quadrix Scores ----------------
Company (Price; Ticker)
Trailing
Curr.
Year
Earnings
Per
Share
(%)
Revenue
Per
Share
(%)
Since
Nov. 8
(%)
Past 12
Months
(%)
Momen-
tum
Value
Overall
12-
Factor
Sector
Reranked
Overall
Industry
AbbVie ($66; ABBV)
13.3
12.0
12
10
15
15
9
65
78
94
63
95
Biotech
Aetna ($145; AET)
16.8
16.1
14
3
9
29
29
26
54
51
44
53
Mgd. care
Amgen
($155; AMGN)
13.0
12.5
11
3
7
14
1
63
86
92
41
94
Biotech
Anthem
($182; ANTM)
14.9
15.5
25
8
7
21
22
63
83
92
63
97
Mgd. care
Baxter Int'l
($59; BAX)
27.3
26.2
75
3
16
24
39
86
50
81
95
80
Equip.
Celgene
($114; CELG)
18.1
15.7
80
21
23
5
8
78
56
85
72
82
Biotech
Centene ($73; CNC)
15.4
15.3
31
84
7
9
16
97
95
100
99
100
Mgd. care
Cigna ($161; CI)
18.8
16.6
4
5
20
25
26
71
67
89
75
87
Mgd. care
HCA Holdings
($82; HCA)
11.9
11.1
18
4
7
1
5
66
94
93
75
98
Facilities
LabCorp of America
($139; LH)
15.6
14.7
11
5
7
10
9
45
80
69
54
82
Services
Thermo Fisher
($173; TMO)
20.2
18.7
14
8
11
13
14
72
49
79
68
75
Life
sciences
UnitedHealth
($175; UNH)
20.3
17.9
26
14
22
24
33
87
60
92
90
88
Mgd. care

 


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