Medical Devices Looking Healthy

5/31/2010


One of the reasons investors have seen few detailed breakdowns of health-reform costs is that even the people in charge of implementing the changes don’t know how much they will cost.

Many of the bill’s provisions as of yet have no dollar amount attached. That uncertainty weighs on health-care stocks — and has opened some attractive buying opportunities in some of our favorite stocks in the equipment group.

The S&P 1500 Health Care Sector Index and the Health Care Equipment Industry Index are down 7% for the year, versus a 3% decline for the broader S&P 1500. While the health-equipment group as a whole is expensive (average trailing P/E ratio of 21 for stocks in the S&P 1500), the average company trades at a 19% discount to its five-year average P/E ratio and earns a Quadrix Overall score of 66.

In April, the federal government released proposed payment rates for cardiac and orthopedic procedures. Most reimbursements increased at low- to mid-single-digit rates, as has been the norm in recent years. Considering the state of government finances, the numbers could have been worse.

There are also signs of recovery on the demand side, as one small survey of hospital administrators suggests capital budgets could increase this year. Neither hospital capital spending nor consumer spending on medical procedures is likely to rise substantially until hiring improves. But industry analysts say the atmosphere at U.S. hospitals is becoming more positive.

A rise in the number of people covered by medical insurance should expand the addressable market for a myriad products. But the recent health-care law also increases regulatory burdens on device makers.

In addition, the federal government also plans to raise $20 billion directly from the industry. Starting in 2013, medical-equipment companies must begin paying an excise tax of 2.3% on the sale of many medical devices. The average medical-equipment company in the S&P 1500 Index is expected to grow per-share profits 14% in 2010 and 18% in 2011.

The table below lists the nine medical-device companies on the Forecasts’ Monitored List. Abbott Laboratories ($47; ABT) and Johnson & Johnson ($60; JNJ) are officially classified as drugmakers, but both operate large equipment businesses.

MEDICAL-EQUIPMENT STOCKS
– P/E Ratio –
12-Month
— Growth —
Est. EPS
— Growth —
Company (Price; Ticker)
Trail.
5-Yr.
Avg.
Sales
(%)
EPS
(%)
Curr.
Year
(%)
Next
Year
(%)

Quadrix
Overall
Score

Advice
Abbott Laboratories
($47; ABT)
13
18
8
11
12
12
76
Buy †
Baxter International
($42; BAX)
11
19
5
12
3
8
73
LT Buy
Hospira ($50; HSP)
15
19
12
29
12
15
78
Focus Buy †
Johnson & Johnson
($60; JNJ)
13
16
0
4
5
8
72
LT Buy
Medtronic
($40; MDT)
12
20
8
12
9
10
83
A
St. Jude Medical
($37; STJ)
14
22
7
16
17
11
95
A
Stryker ($53; SYK)
17
24
4
7
11
12
84
Buy †
Varian Medical Sys.
($49; VAR)
17
24
5
14
9
12
88
Focus Buy †
Zimmer Holdings
($55; ZMH)
14
18
3
2
8
11
79
B
S&P 1500 Health
Care Equip. Avg.
21
26
5
9
14
18
66
Notes:  Averages exclude P/E ratios below 0 or over 75 and growth rates of more than 100.  Quadrix scores are percentile ranks, with 100 the best.    † Also qualifies as a Long-Term Buy.

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