* All data are as of the close of Wednesday, December 10, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
The healthcare sector as a whole is expected to benefit greatly over the coming years from the continually increasing enrollments into healthcare insurance plans. Not only are employers with 50 employees or more mandated to provide healthcare insurance to their employees, but individuals are also mandated to sign up for private health insurance if none is available at their employment.
The new reforms which came into effect at the start of 2014 have already signed-up an estimated 7 million new recipients of private healthcare insurance, which number is expected to rise to between 9 and 10 million in 2015. And we all know what it means when more people have access to medical services… more traffic at hospitals and clinics, and more demand for procedures and medications.
Hence, numerous industries within the Healthcare Sector are expected to enjoy stellar earnings growth for years to come, some of which I have already compared, including the hospitals industry, the home healthcare industry, the drug related products industry, and the healthcare information services industry.
Yet the Specialized Health Services industry is a little too diverse for investors to simply pick any company in the group and just run with it. This is an industry you need to sift through and cherry pick those companies with the best fundamentals and future prospects, as not all will be carried along for the ride.
To this end, we'll need to look at what each of the nation's largest three companies in the space offers.
• DaVita HealthCare Partners Inc. (NYSE: DVA), headquartered in Denver, Colorado, provides kidney dialysis services and related lab services primarily in outpatient dialysis centers and in contracted hospitals, as well as home-based hemodialysis services. It owns its own clinical laboratories that provide routine laboratory tests for dialysis and other physician-prescribed laboratory tests for ESRD patients, in addition to management and administrative services to outpatient dialysis centers. It operates some 2,173 outpatient dialysis centers, including 2,098 centers located in the U.S., and 75 centers located in 10 other countries.
• Omnicare Inc. (NYSE: OCR), headquartered in Cincinnati, Ohio, specializes in the management of pharmaceutical care, offering pharmaceuticals and related pharmacy and ancillary services to long-term care facilities, and chronic care facilities among others. Its services are used by skilled nursing facilities, assisted living facilities, independent living communities, hospitals, correctional facilities, and other healthcare service providers. It also provides pharmacy consulting services, including monthly patient drug therapy evaluations, assistance in compliance with state and federal regulations, as well as proprietary clinical and health management programs. Additionally, it operates an online platform for electronic ordering of prescription refills, intravenous medications, and nutrition products, offering proof-of-delivery tracking and real-time validation of Medicare Part D coverage.
• MEDNAX, Inc. (NYSE: MD), headquartered in Sunrise, Florida, provides newborn, anesthesia, maternal-fetal, and other pediatric care services including: neonatal care services, clinical care to babies born prematurely or with complications, anesthesia care services, anesthesia sub-specialty care, and acute and chronic pain management services through outpatient medical offices, hospital clinics, and ambulatory service centers. It also provides maternal-fetal care services to expectant mothers and their unborn babies through affiliated maternal-fetal medicine sub-specialists, obstetricians, and other clinicians such as maternal-fetal nurse practitioners, certified nurse mid-wives, ultrasonographers, and genetic counselors. Additionally, it provides pediatric cardiology care services of fetus, infant, child, and adolescent patients with congenital heart defects and acquired heart disease, as well as adults with congenital heart defects.
With such diversity of services offered, we can understand why the three companies have performed so differently during the economic recovery, as graphed below.
Since the bull market officially began on March 9th, 2009, where the S&P 500 index [black] has gained some 205% and the SPDR Healthcare Sector ETF (NYSE: XLV) [blue] has gained 222%, the three largest U.S. companies in the industry have split performed, with DaVita rising an impressive 240%, Omnicare rising a market-performing 205%, and MEDNAX rising an outstanding 410%.
On an annualized basis, where the S&P has averaged 35.65% and the XLV has averaged 38.61%, Omnicare has averaged a stable 35.65%, DaVita has averaged a healthy 41.74%, while MEDNAX has averaged a resilient 71.30% per year!
The future for the Specialized Health Services industry as a whole looks quite fit and sound when comparing its earnings growth to that of the broader market's, as tabled below where green indicates outperformance while yellow denotes underperformance.
Over the current and next quarters the industry's earnings are expected to grow at some 2.41 to 3.46 times the S&P's average growth rate, before calming to a more sustainable 2.25 times in 2015 and 1.77 times annually over the next five years.
Zooming-in a little closer, the three largest U.S. companies in the industry are expected to split perform with a little unexpected surprise twist, as tabled below.
While all three are expected to under-grow the broader market's earnings over the current and next quarters, the once stable DaVita slips from second place to third as its earnings shrink in the current quarter, with its underperformance expected to continue longer term as well.
The remaining two competitors also deliver a surprise as the third place performer during the bull run, Omnicare, ultimately grows its earnings faster than even the top performer MEDNAX from 2015 onward, beating the S&P's average earnings at some 1.17 to 1.61 times its growth rate over the longer term.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, MEDNAX delivered the greatest revenue growth year-over-year, where Omnicare delivered the least.
Since Omnicare's year-over-year earnings growth is not available, the metric does not factor into the comparison, though it is worth noting that DaVita's earnings vastly outgrew MEDNAX's.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, MEDNAX operated with the widest profit and operating margins, while Omnicare contended with the narrowest.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, MEDNAX's management team delivered the greatest returns on assets, where DaVita's team delivered the greatest returns on equity, while Omnicare's team delivered the least of both.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, MEDNAX provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Omnicare's DEPS over current stock price is lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Omnicare's stock is cheapest relative to forward earnings and 5-year PEG, where MEDNAX's stock is cheapest relative to company book value. At the overpriced end of the scale, DaVita's stock is the most overvalued relative to all three ratios.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Omnicare offers the highest percentages of earnings over current stock price for all time periods. At the low end of the spectrum, MEDNAX offers the least percentage for the next quarter, while DaVita offers it for all remaining periods.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, MEDNAX offers the greatest earnings growth in the current and next quarters, where Omnicare offers it in 2015 and over the next five years. At the low end of the scale, DaVita offers the slowest growth throughout, with shrinkage expected in the current quarter.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe DaVita's stock offers the greatest upside potential and greatest downside risk, while Omnicare's stock offers the least upside and MEDNAX's offers the least downside.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Omnicare is best recommended with 1 strong buy and 7 buys representing a combined 88.89% of its 9 analysts, followed by MEDNAX with 6 strong buy and 5 buy ratings representing 61.11% of its 18 analysts, and lastly by DaVita with 4 strong buy and 2 buy recommendations representing 37.50% of its 16 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… MEDNAX by a healthy lead, outperforming in 14 metrics and underperforming in 6 for a net score of +8, followed not far behind by Omnicare, outperforming in 12 metrics and underperforming in 10 for a net score of +2, with sickly DaVita crawling along in third place, outperforming in 4 metrics and underperforming in 15 for a net score of -11.
Where the Specialized Health Services industry is expected to outperform the S&P broader market substantially this and next quarters, significantly in 2015, and meaningfully beyond, the three largest U.S. companies in the space are expected to trade places where earnings growth is concerned, with DaVita slipping into third, MEDNAX slipping into second, and once underperforming Omnicare enjoying a growth spurt greater than all of them, including the broader market.
Yet after taking all company fundamentals into account, MEDNAX is found to have the soundest financial vital signs, given its lowest stock price to company book value, lowest debt over market cap, highest trailing revenue growth, widest profit and operating margins, highest returns on assets, highest EBITDA over revenue, highest diluted earnings over current stock price, highest future earnings growth near term, best mean and low price targets, and most analyst strong buy recommendations - decisively winning the Specialized Health Services industry examination.