Health-Care Firms That Survived ‘80s Warrant a Look
In a weak economy that’s getting weaker, some investors are looking at hospital and health maintenance organization stocks--which spent most of the late 1980s in the doghouse.
The group’s annual profit growth has been in the 15% to 20% range lately, yet many of the stocks still sell for reasonable prices relative to expected 1990 earnings per share. The health-services industry has gone through a tremendous shakeout, and the remaining firms appear strong and viable. “The people who have done the job right are those who survived,” says Mike Gerding, whose Founders Equity Income mutual fund in Denver owns several hospital and HMO stocks.
What’s more, given the aging American population, health care ought to be a growth industry in the 1990s regardless of the economy. You can put off buying a car, after all, but you generally can’t choose when to be sick.
Sound familiar? Investors who were around in the early 1980s heard a lot of the same arguments in favor of health services. Hospital firms such as Humana were among the hottest stocks from 1980 to 1983. Then, the growth abruptly stopped.
What happened in the mid-80s was a sudden combination of too much competition and Uncle Sam’s decision to slash Medicare reimbursement in an attempt to slow the rise in health-care costs. For many hospital firms, the combo was a knockout punch. Yet in retrospect, the blow was one that Wall Street should have seen coming. Things had gotten out of hand.
If there’s a single factor that holds some investors back from health services today, it’s simple fear of an even worse backlash over the rising costs of medical care.
To Seth Shaw, analyst at Prudential-Bache Securities, it boils down to this: Despite all of the lip service paid to controlling health-care costs, private employers and the federal government have continued to see their costs soar. HMOs, Shaw notes, mushroomed in size in the late ‘80s largely as an answer to private doctors’ escalating charges. The HMOs promised to save companies money by providing managed health care at set annual costs.
Yet even the HMOs have continued to raise their charges at double-digit rates. Shaw says companies just can’t afford that anymore. “We are more convinced than ever that corporate America cannot tolerate 15% to 20% rate hikes ad infinitum,” he says. A recession will only make the decision more urgent for companies, he says. “We see a cyclical--and probably secular--change within the next two to three years,” he says, in corporate attitudes toward health costs.
If there is indeed a revolution beginning, Medicare may have fired the first shot this week. The government announced that the 1991 rate increase for contract Medicare providers will be in the 1% to 2% range. For some Medicare contractors--such as Fountain Valley-based FHP International, an HMO that has built a big business serving senior citizens in Southern California--the net increase may work out to 5% to 6% because of Medicare’s elimination of some catastrophic benefits that FHP has been required to offer.
Nonetheless, the rate increase is slim. What that means for Medicare providers is that, to keep profits rising at a healthy pace, they will have to do better than ever at controlling their costs. Or they’ll be forced to cut back on the services they provide, hurting their competitiveness.
FHP has been a great story in recent years. Enrollment in the HMO has been growing about 20% a year compounded, and the firm now has a total of 560,000 enrollees in California, Utah, Arizona, New Mexico and Guam. Only about 160,000 of those enrollees are Medicare recipients. Yet they provide about 60% of FHP’s revenue.
FHP’s earnings per share have jumped from 28 cents in 1987 to $1.30 in the year ended June 30, before a one-time charge. In this fiscal year, Wall Street thinks that FHP could earn $1.64 a share, a gain of 26%. Yet the stock has been pushed down from $26.375 to $14.25, mostly on fears that Medicare’s penny-pinching will pinch FHP too.
Is FHP worried? Westcott Price III, the firm’s president, notes that FHP has become well known for managing costs, providing full services to its HMO enrollees and making decent money at the same time. FHP has been planning for the lower Medicare increase, Price says, “and at this moment we don’t have any plans to change benefits. It may not be necessary for us to make any changes.”
Fears that private companies will follow Medicare’s lead have caused the same questions about future profit margins to dog companies such as National Medical Enterprises, the Santa Monica-based firm that runs 140 acute-care, psychiatric and substance-abuse centers.
NME is one of the strong hospital survivors of the ‘80s shakeout. On the surface, it’s a cheap stock. Earnings rose 15% in the year ended May 31, to $2.67 a share, fully diluted. Analyst Rae Alperstein at Bateman Eichler, Hill Richards thinks $3.07 is possible this year.
So why has the stock fallen back to $34.50 from $40.25 a share? Pru-Bache’s Shaw is worried that NME’s big investment in psychiatric centers could pose problems. There has been a growing debate over the value of psychiatric and substance-abuse programs, and about the cost. While many companies have felt compelled to offer such programs as part of their health packages in recent years, firms that suddenly decide to cut back on health plans could target the psychiatric and substance-abuse benefits first.
Whether that will happen, however, remains to be seen. For all the worry about what Uncle Sam and private companies may do to health-service firms’ profit margins, there are two good points to remember: First, most of the firms that survived the ‘80s are unquestionably the smart players. To sell them short on their ability to cope with the ‘90s may be a wrong move. Second, while private companies may want more cost-control help from health-services firms in the ‘90s, it isn’t in the companies’ interest to put their preferred care providers out of business.
At the very least, the drop in the stocks’ prices has taken some of the risk out of them. For investors with an interest in the health-care business, it may be a good time to weigh the remaining risk with the potential reward.
WAYS TO PLAY HEALTH CARE Hospitals/nursing homes
52-week Thurs. ’90 Stock high/low close P-E* Beverly Enterprises $8 1/2-$3 3/4 $5 3/8 36 Community Psych. 34-19 3/4 24 13 Humana 50 7/8-33 43 5/8 13 Manor Care 17 7/8-10 1/4 12 5/8 14 Natl. Medical Ent. 40 1/4-29 1/4 34 1/2 11
HMOs
52-week Thurs. ’90 Stock high/low close P-E* FHP Intl. 26 3/8-11 1/2 14 1/4 9 PacifiCare Health 30 3/8-12 16 11 United Healthcare 19 1/2-7 7/8 17 1/2 14 U.S. HealthCare 22 1/4-9 5/8 20 19
Outpatient/home health care
52-week Thurs. ’90 Stock high/low close P-E* Care Plus 21-7 3/4 18 3/8 30 Medical Care Intl. 41 1/4-18 1/8 38 27 Salick Health 11 3/4-5 1/2 7 3/4 14 Surgical Care Affil. 17 1/4-8 1/8 16 1/4 36
* stock price-earnings ratio based on estimated earnings per share for the current fiscal year, using analysts’ consensus estimates from Zacks Investment Research
* stock price-earnings ratio based on estimated earnings per share for the current fiscal year, using analysts’ consensus estimates from Zacks Investment Research
