Are Healthcare Stocks More Vulnerable to Recession?

Over the last 10 to 15 years, employers have been shifting healthcare costs to their workers by paying smaller percentages of their health insurance premiums and raising deductibles and co-pays on expensive new drugs and some procedures. This is likely to make hospitals, medical group practices, pharmaceutical companies, medical supply distributors and alternative healthcare providers much more vulnerable to a recession than they have been historically.

At the same time, the increased consumer sensitivity to healthcare costs and their exposure to recessions and their increased tendency to delay medical procedures until they feel better about the economy may help health insurers and HMOs. This may help them if the recent increases in medical claims are slowed or even reversed.

Back in December, Price Headley at Big Trends traced the history of healthcare stocks' performances in recent recessions when healthcare stocks out performed the general markets. On April 3, he updated his analysis of the healthcare sector and medical stocks. His charts show that year-to-date, healthcare is the second worst performing sector and that in March it was the worst performer.

But he doesn't offer an explanation. On March 25, Business Week did a nice job of demolishing the myth that healthcare companies are recession proof. The concluding impact graphs: Paul Keckley, executive director of the Deloitte Center for Health Solutions, sees three likely impacts from a recession: Primary and preventive care will be delayed, people with high deductibles will delay payments on care received, and there will be an increase in the number of bankruptcies from medical debt. "You can't separate the economy from healthcare. It's 17% of the [gross domestic product] right now and it will be 20% of GDP in seven years," says Keckley. The industry "had a pretty good run for 25 years, but now there are all these Scud missiles flying at it."

One of those missiles is the turmoil that gave rise to the current economic malaise. The crisis in the credit markets is taking a toll on nonprofit hospitals, which fund their capital spending with variable-interest bonds. The rising cost of borrowing can't be passed along right away with higher prices for medical care because Medicare, Medicaid, and most insurers negotiate reimbursement rates that are set two years out. On top of all that, it's difficult for hospitals to cut staff or salaries given the extreme shortage of nurses and other health-care workers. "We're essentially a fixed-cost business," says Beth Israel's Levy. The only choice many hospitals have will be to delay or cancel capital investments. In other words, says Keckley, put the health-care industry together with a recession and there's only one likely result: "It's a mess."

Over the weekend, Morningstar.com discussed healthcare stocks as a haven from the recession, and it does a good job of recounting the history of healthcare stocks' performances during recessions. But it says nothing about the impact of the shift of healthcare costs to insured patients. The article lists several stocks investors should consider. It suggests investors should look at Schering-Plough (SGP), Novartis (NVS), Quest Diagnostics (DGX) and Mylan (MYL). I wonder.

We're in earnings season, and this week Johnson and Johnson (JNJ) will be the most prominent healthcare company reporting its earnings and talking to securities analysts and traders on its conference call. It will be interesting to see whether the company discusses the impact of the current economic slow down and credit market turmoil on its business and outlook. Analysts should ask these questions:

1. What has been and will be the impact of inflation, a 14% to 15% rise in import prices, rising unemployment and sinking consumer confidence on demand for your consumer products, medical supplies and medical equipment?
2. How important has the shift of healthcare and medical costs to insured workers by their employers been in your consumer and institutional markets, and what do you think is happening with the healthcare consumer?
3. Which of your product lines are most likely to be affected by rising consumer concerns about their jobs, insurance and inflation?

When WellPoint (WLP), Humana (HUM), Health Net (HNT), Coventry (CVH) and UnitedHealth Group (UNH) report, it will be interesting to see whether they report seeing the impact of the slowing in the economy and recessionary expectations. Also, pay close attention to the reports by hospital companies such as Universal Health Services (UHS), Tenet (THC), Lifepoint (LPNT) and Health Management Associates (HMA).

Disclosure: I don't own any of these stocks.