Three Attractive Valuations in Health Care

We recently had the chance to discuss with Zacks' senior health care industry analyst Chris Kallos what his impressions are of the industry in general looking forward. We also got a few names of companies he recommends in the space.

Have you issued any Buy reports on health care companies under your coverage recently?

After the big sell-off of Health Net (HNT) shares, we upgraded our rating to a Buy on the company. Health Net, based in Woodland Hills, CA, is one of the nation's largest publicly traded managed healthcare companies, offering a full range of healthcare services. HNT’s contract with the Defense Department to 2.9 Military Health System [MHS] eligible beneficiaries (active duty personnel and TRICARE/Medicare dual eligible beneficiaries) represents a stable revenue stream over the life of the contract.

What’s more, HNT’s broad product offering, significant market share in the key states of California and New York, and relatively stable military related business, make it a potential acquisition target given industry consolidation trends.

Recent negative press about the affordability of health care has put downward pressure on the healthcare industry in general, but we think Health Net’s recent sell-off has opened a nice buying opportunity here. We have valued HNT on a forward price/earnings (P/E) basis, as well as in comparison to similar firms in the managed care sub-sector of healthcare. Our $35 price target is derived using a multiple of 8.6 x FY08 EPS of $4.07.

What is your outlook currently for the industry as a whole?

Right now, we are market neutral on health care stocks overall. Industry fundamentals for government-sponsored programs, in particular, remain positive as individual states continue to collaborate with third party managed care providers to coordinate Medicaid programs in addressing the issue of the rising cost of health care for specific sub-groups of the population.

Nonetheless increasing competition among providers, coupled with aggressive geographical expansion, is increasing investor focus on management of internal costs. Furthermore, the Medicaid managed care industry in particular is highly regulated with respect to government funding and subject to close monitoring by state agencies for levels of profitability. We note that Medicaid rates and eligibility criteria have in the past been subject to changes following changes in state administration policy.

Any other recent Buys worth noting?

Late last month, we upgraded Humana (HUM) from a Hold to a Buy. HUM is one of the largest publicly traded health benefit companies in the U.S. and Puerto Rico.

We took note of the reaction to the recently revised FY08 guidance by the company, following updated projections for the company's FY08 stand-alone PDP segment, and decided it was overdone. Notwithstanding the company’s exposure to reimbursement risk through its reliance on Medicare, recent acquisitions such as OSF HealthPlans, and TRICARE’s recently issued formal request for proposal to managed care providers, augur well for earnings stability over the long term.

Also, Allion Healthcare (ALLI) is rated a Buy. ALLI is a national provider of specialty pharmacy and disease management services focused on HIV/AIDS patients. The company recently reported 4Q07 net income of $1.1M or EPS of $0.06, inline with expectations, compared with net income of $380,000 or EPS of $0.03 in 4Q06.

ALLI also announced its deal for privately held Biomed America is expected to be EPS accretive in FY08. Notwithstanding the increased exposure to integration risk, we believe the stock is attractive, and that’s why we moved to a Buy recommendation.