Medical Costs Are Front and Center in Healthcare

Many investors have lately been looking toward the longer-term strength of industries such as healthcare. But what about the shorter term? We asked Zacks senior healthcare industry analyst Chris Kallos about the state of healthcare investments, and which Buy recommendations he would make for us.

With earnings season winding down, have companies in your coverage performed as expected? Were there many surprises?

Most managed care organizations have reported broadly in line with expectations. Medical costs have remained the center of investor focus given the tight premium over cost spreads, due in most cases to the higher-than-expected cost of servicing Medicare drug plans. Although medical loss ratios in many cases have improved on a sequential basis, many remain high in year-on-year terms.

The slowing economy in the U.S. and now elsewhere has created a drag on many industries. Where specifically has it hit your coverage thus far?

A slowing economy has limited the ability to raise premium rates to meet higher-than-expected medical costs. In the current economic climate it is difficult to reset premiums and pass along the higher medical costs to customers.

What is your near- to mid-term outlook on companies you cover?

Overall our stance is neutral. However, even within the managed care arena, companies vary in terms of geographical spread, scale of operation, business mix (Medicare, Medicaid, Individual, etc.) and source of revenue. As a result, the dynamics of each managed care differ given the focus of its product and payor mix. That said, we believe several of the larger players are attractive at current levels.

If you have two or three top Buy recommendations at this time, which stocks would they be?

WellPoint (WLP) and Humana (HUM) stand out at this time. WellPoint is the largest publicly traded commercial health benefits company in the United States and an independent licensee of the Blue Cross and Blue Shield Association. Humana reported a revenue increase of 14% driven by a 19% increase in the membership of its Medicare Advantage program, as well as the addition of CompBenefits and KMG America. Both companies are attractive on a valuation basis at current levels.

What should investors be mindful of before jumping into your industry?

We believe managed care is a vital link in the delivery of healthcare for both commercial and government customer groups. Patient long-term investors should be mindful of the impact of slowing economies in not only the growth of members but also in the ability for service providers to pass on premium rate increase to end customers.

2008 has demonstrated the challenges faced by managed care companies managing medical cost inflation with limited pricing power. In addition, investors should remain mindful of the impact of government policy and reimbursement risk inherent in this sector, especially this election year where Medicare has been a hot topic for Congress.

Chris Kallos is a senior analyst covering the healthcare industry for Zacks Equity Research.

Comments

[srs]

It's too bad these profits come off the backs of doctors and from denying patient care.

2008 Aug 15 01:11 PM