Matthew D. McCall's  Instablog

The debate across American rolls on as both sides of the aisle attempt to push their version of the health care reform down the throats of taxpayers. There is no doubt in my mind that some type of major changes will occur in the industry in the next year or so, the question what and when? This uncertainty has forced me to underweight the health care sector in our newsletter and for clients. But after doing some more research this past week, I have found four health care stocks that are poised to do well with or with reform sweeping across the industry.

 

As part of the stimulus package, approximately $850 million will be allocated to community hospitals for upgrades to equipment, including IT. President Obama also pledged several times over the last year to put $40 billion in upgrading the nation’s health care IT from paper to electronic. This is a move that is well overdue and can help eliminate costs over the long-term.

 

Quality Systems (QSII) - The health care IT company reported Q1 2010 earnings on 7/30 and net income came in below expectations. Earnings per share came in at $0.36, down from $0.40 one year earlier. The put some of the blame on the uncertainty surrounding the stimulus money that has been earmarked for upgrading the nations health care IT. As we all know the US government has not spent the money it has promised to taxpayers and QSII and others in the sector are directly affected. On a positive note, the company was able to grow revenues by 21% to $66.6 million in the quarter - a new record. The consensus estimate for earnings in fiscal 2010 is $1.75/share and $2.32 in 2011. The real growth appears to be in the next few years, however with the stock currently trading with a P/E ratio of 24.6 based on 2010 numbers it may already be fairly valued. An entry in the high $40’s would be more attractive to me.

 

Cerner Corp (CERN) - A competitor to QSII, Cerner is the leading US supplier of health care IT and it shows in the numbers. Annual revenue has nearly doubled from 2005 to 2009 and earnings have achieved that goal. The company is expected to report earnings per share of $2.42 in 2009, giving it a P/E ratio of 26.8. Analysts expect earnings of $2.83 in 2010 and $3.59 in 2011. Similar to QSII the large growth is expected to return in the coming years. If I were to try and create a target price for QSII in 2011 based on earnings it would be $99 based on a PEG ratio of 1.0 and earnings growth of 27% from 2010 to 2011. Based on the current price of $65, a move to $99 would be a 52% gain. Not bad in approximately two years considering the company has consistently grew both the top and bottom line and it has the government (supposedly) spending behind it.

 

HMS Holdings Corp (HMSY) - The company is the country’s leader in cost containment, coordination of benefits, and program integrity services for government health care programs. Consider the possibly of the government playing an even larger role in health care, you cannot think about HMSY and how beneficial their services may become. The company is already recovering over $1 billion per year for clients. Fundamentally the company is strong on both the top and bottom line. In the second quarter revenue grew by 21% over last year as earnings per share jumped to $0.24 versus $0.19. During the recent conference call the company raised its guidance for 2009 to $1.05 EPS on revenue of $222 million. Over the last five years HMSY has grown revenue by 4-fold with the stock price jumping over 500%. The current 2009 estimates call for revenue to increase by 20% and earnings by 31%. If I were to calculate a price target for HMSY in the same manner as CERN based on earnings of $1.81 in 2011 and growth of 38% the end result is $69 or a 79% increase from the most recent price of $38.68.

 

All three stocks have the potential to outperform the overall market in the coming years with or without a major reform to the current health care landscape. Of the three stocks HMSY has the most upside potential fundamentally and the chart is setting up for a nice buy between $37 and $38.