Healthy Returns

The MoneyLetter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

– John Stephenson, CFA For better or for worse, Obamacare is now the law of the land in the U.S., with the individual mandate in effect since the start of 2014. Healthcare currently accounts for a sixth of U.S. GDP, and some estimates suggest that extending health coverage to upwards of 32 million uninsured Americans could boost health spending by one percent (or 0.2 per cent of GDP) over the next few years. This makes healthcare a very big deal indeed.

So far, the rollout of the Affordable Care Act (or Obamacare, as it is euphemistically called) has been an unmitigated disaster. The website has crashed repeatedly and the public is up in arms over the fact that big business gets to delay its implementation for a year while individuals don’t.  

Some have questioned why the public face penalties if they don’t want to sign up, yet smaller businesses have slashed the hours of workers to avoid implementing the law.

Many are concerned that the higher cost imposed on firms employing 50 or more full-time workers could lead to a marked rise in part-time work at the expense of full-time jobs.

It wasn’t supposed to be this way. President Obama sold people on the Affordable Care Act by promising that you could keep your doctor and insurance plan, and that the average family would see their premiums drop by up to $2,500 per year. And for many of the formerly uninsured and the poor, that’s indeed the case.

The problem is that many middle and upper-middle class families are getting hammered under Obamacare. Some of these people are seeing the cost of their insurance soar for even an annual bare-bones plan by $15,000 or more.  

To give greater coverage to more people and those who are generally sicker, the only way to square the circle is to widen the base by getting everyone to sign up.

The healthy and the young are needed to subsidize the old and the sick. But given the disaster the rollout has been so far, and the very pointed criticism of the plan by former supporters of the law, the question is: will they?

Maybe it’s easier and cheaper for many young people to forgo signing up and opt to pay the penalty instead.

In retrospect, the plan was doomed from the start. Since a single-payer system would be dead on arrival in America, President Obama’s signature healthcare legislation had to be jerry-rigged in such a way as to appease the pharmaceutical lobby, the doctors’ lobby, and a thousand other special interest groups.

That, and the fundamental premise that the old, poor and the sick could be taken care of in a country where freedom of choice is a national value. Don’t forget, too, the problem of an aging demographic, and a propensity in a litigious society to over-prescribe for everything.

Take some recent examples, such as a routine birth in Chicago with mild complications that resulted in a bill for $85,000. Or a pacemaker replacement performed on an otherwise healthy 83-year-old in Massachusetts. The cost: over $100,000.   

Insurers don’t bargain particularly hard because they just pass the costs onto the consumer. To be fair, they are in no position to bargain since it is the insurance company that is paying the bills. The Affordable Care Act does nothing to address the bloated cost structure inherent in the system.  

While Obamacare may have turned out to be a dud, it’s been a boon to health stocks. In fact, healthcare is a top-performing sector on the S&P 500.

Health stocks have been boosted thanks to the near-perfect storm of the planned implementation of the Affordable Care Act and an aging demographic with soaring health needs. They are cheap relative to their historic norms, and the sector has the second-most cash on the balance sheet after the technology sector.  

Obamacare isn’t the only thing driving the healthcare bandwagon

To be clear, Obamacare isn’t the only thing driving the healthcare bandwagon, but it is a significant contributor toward increased demand for health service in the U.S. Clinical/physician services and prescription drugs are all likely to be in greater demand as a result of the implementation of the Affordable Care Act.

So while the law has turned out much worse than many imagined, for investors it’s been heaven-sent, as the healthcare sector offers the best combination of prized cyclical and defensive characteristics.

They do well in times like these when there’s a cyclical bull market in health stocks. And when markets are weak, the steady cash flows they generate are valued by investors.

This group of stocks is uncorrelated with one another, making individual stock performance a matter of company-specific fundamentals rather than group dynamics. It’s a sector best suited to individual stock picking rather than a broad-based ETF approach.

A few favourites

Despite the strong returns of many health stocks in 2013, the group is in the midst of a secular bull market which should continue to lift valuations in the years to come.

An aging demographic, millions of Americans receiving health insurance for the first time and a global economy on the mend have set the stage for continued healthy returns for investors in this sector.

One name that I really like is Allscripts Healthcare Solutions (NASDAQ-MDRX, $14.96).  

Allscripts is a provider of clinical, financial, connectivity and information solutions and related professional services to hospitals, physicians and post-acute organizations. Its Sunrise Enterprise suite consists of a range of acute care Electronic Health Records integrated with financial and administrative solutions for hospitals and health systems, including performance management and revenue cycle as well as access management.

I believe the growing share of recurring revenues (in part due to the company’s large installed physician base) combined with recent bookings trends sets the company up well for improving trends this year.

Although Allscripts has been one of the top performers in the healthcare technology universe in 2013 (shares up 61 per cent year-over-year), I believe its earning power may still be undervalued.

* My Advice:  I rate Allscripts a buy with a 12-month target price of $20 per share.

Another name that I really like is Thermo Fisher Scientific (NYSE-TMO, $102.22). It is the largest and most diversified life sciences company. It offers a comprehensive product portfolio consisting of analytical instrumentation, lab equipment, consumables, software and services used for research, drug manufacturing, diagnostics, food and consumer product safety, and environmental testing.

* My Advice: Thermo Fisher Scientific is a buy with a 12-month target price of $122 per share.

With health costs on the rise, generics will play an increasing role in solving medical needs for an aging population.

One name that is a favourite of mine is Mylan Inc. (NASDAQ-MYL, $41.74). The company develops, manufactures, markets and distributes generic and brand pharmaceuticals. Through a combination of organic growth and some significant acquisitions (Matrix for active pharmaceutical ingredients and Merck KGaA’s generics division mainly for ex-US revenue diversification), it has grown into one of the leading players in the global generic pharmaceutical industry.

Despite strong performance over the past several years, Mylan shares trade at only 13 times and 11 times my 2014 and 2015 EPS estimates, respectively.

With a core business that is capable of generating double-digit earnings per share over the next five years, an overall generic portfolio that is shifting into high margin, more durable opportunities and a number of other potential upside drivers, I think the price earnings multiple on Mylan can expand. * My advice:  I rate Mylan Inc. a buy with a 12-month target price of $50 per share. Healthy Alternative

Markets have been skittish of late, with investors fretting over whether or not the solid gains of 2013 can be sustained in 2014. Also weighing on investors’ minds is whether or not the U.S. Federal Reserve will take away the punchbowl in the form of reducing (tapering) some of its $85 billion per month in stimulus to the U.S. economy.

But despite the concerns over the direction of the economy and the stock market, the healthcare sector – an already massive part of the U.S. economy – is going to get even bigger as the flawed but well-intentioned Affordable Healthcare Act begins to take effect.

That sets the stage for a multi-year expansion of earnings and revenue for many health stocks – and some welcome news for investors.


The MoneyLetter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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