HMO Selling Frenzy Was Ill-Advised
Wall Street’s growing paranoia about the health care industry has claimed yet another victim: the health maintenance organization stocks that were supposed to represent the solution to the unbridled inflation of medical costs in America.
The HMO stocks were crushed last Thursday and Friday on fears that the premiums they charge clients will be severely squeezed in the future, as businesses and local government units revolt against price hikes from health care providers in general.
Though many analysts say the stocks’ plunge was illogical, there may be more to come in the short term. Because the HMOs have been hot stocks for so long, they have become a favorite investment sector for “momentum” players--short-term traders who ride issues that are going up, only to abandon them in droves at the first sign of trouble.
The catalyst for the HMO carnage was an announcement last Wednesday from the California Public Employees Retirement System, which said it had forced an actual 0.2% decrease in average 1993 premium rates from 19 HMOs serving 692,000 CalPERS members (state government employees and their dependents).
By Friday, investors nationwide were fleeing all HMO stocks, on the belief that CalPERS’ pact with its HMOs will inspire other large care sponsors to demand similar premium cuts--eventually slashing the profits of the HMOs.
President Clinton, who has been jawboning the medical cost-cutting issue every chance he gets, may have added to the selling frenzy Friday when he attacked drug companies for their “shocking” prices. Some HMO shareholders may have decided that the HMOs are next in line to be pilloried.
Among the biggest stock casualties Friday were industry leaders such as Blue Bell, Pa.-based U.S. HealthCare, which fell $4.125 to $48.375; United HealthCare in Minnetonka, Minn., down $6 to $55.875, and Rancho Cordova-based Foundation Health, off $5.50 to $33.625.
Some HMO officials said they were stunned by the magnitude of the selling. “We think it’s a complete overreaction,” said Michael Montevideo, treasurer of FHP International, based in Fountain Valley.
Wall Street analysts say HMOs unquestionably will face further pressure to slow rate increases. But focusing solely on rates misses the bigger picture: The move toward managed care should bring HMOs millions of new members in the 1990s who can be served profitably by sharply run organizations.
HMOs are still part of the answer to the nation’s health care cost woes, not part of the problem. The same cannot be said of either the drug industry or the hospital industry.
Here’s what analysts say HMO investors should keep in mind:
* Competition isn’t a new concept for HMOs. In California, HMOs such as Foundation Health, FHP, PacifiCare Health Systems and others have thrived over the years despite aggressive competition from each other and from private Kaiser Permanente, the industry’s 400-pound gorilla.
Annual rate increases at California HMOs were typically in double digits a few years ago. Now they’re more like 5% to 8%. Yet the HMOs’ overall profit growth has remained stellar as membership has ballooned.
Earnings at Cypress-based PacifiCare, for example, have rocketed 271% since 1989, from 48 cents a share that year to $1.78 last year, as the firm’s enrollment has approached 1 million members. This year PacifiCare is expected to earn about $2.10 a share.
* CalPERS’ contract won’t be a national standard. CalPERS has been able to press cost reductions by sheer force of its immense size. Few other care sponsors have that much clout. “CalPERS is always going to be below the market (rate),” says Tom Hodapp, analyst at the brokerage Robertson, Stephens & Co. in San Francisco.
What’s more, CalPERS can play hardball in California because HMOs are so dominant here.
In many other states, HMO enrollment is still relatively low, even though HMOs offer far more attractive health care plans (from cost-conscious companies’ points of view, if not their employees’) than insurance companies.
The net result is that pricing pressure on many HMOs outside California isn’t severe at all, at least not yet. U. S. HealthCare, for example, was recently awarded a 12% rate hike on a key Pennsylvania contract.
* Rate increases or decreases don’t tell the whole story. When revenue is threatened, a company naturally looks to keep profits rising by paring expenses.
That is already second nature for most HMOs, which were created in the first place to seek cost savings.
“On the cost side, we’re becoming more efficient,” says Kurt Davis, investor relations director for Foundation Health. “We know that one product (of health care reform) is going to be lower rates.”
In addition, premium changes don’t show what’s happening to the coverage the HMOs provide.
“What a lot of HMOs are doing is adjusting their plans,” Hodapp says, in some cases limiting benefits to keep services in line with the reimbursement provided.
HMOs have also become masters of product innovation, offering new services in a host of different packages, all designed to cut employers’ health care expenses. United HealthCare, for example, on Friday launched a program called Diversified Senior Rx, which the company said can lower corporations’ retiree prescription costs by as much as 40% through close monitoring of patients’ drug use.
* A national health plan would most likely center on HMOs. If Clinton is serious about providing health care for all, HMOs are the obvious vehicle.
Even before such a plan becomes reality, more businesses and government units are likely to band together to negotiate less-expensive medical contracts covering more people. That trend, too, favors HMOs.
Indeed, while many investors are focusing on rate issues, they’re ignoring the potential benefit to HMOs from the far greater volume of patients--and dollars--they’ll handle as more people come into the system.
“With these changes will come tremendous numbers of people into managed care who weren’t there before,” says Davis.
With the long-term trend highly favorable for HMOs, the only issue is the stocks’ level: What’s a fair price to pay?
Admittedly, some of the biggest HMO stocks had reached stratospheric valuations in recent months, as investors fleeing drug stocks barreled into HMO issues, looking for more promising health plays.
Some HMO stocks had been trading at prices that were 30 to 50 times their most recent 12 months’ earnings per share--double or triple the average stock’s P-E.
But with last week’s 10% to 20% declines in the stocks, the P-Es on several HMO stocks are already below 20.
If the industry’s annual earnings growth rate remains in the 15% to 20% range a few years from now, as many analysts insist, the stocks may already be very reasonable.
They could, however, get cheaper still, as the short-term traders who’ve profited from the stocks’ huge run-ups last year continue to take their profits and jump ship.
Hodapp, for one, worries that between the momentum players’ exit and the angst over the CalPERS announcement, HMO stocks could fall another 5% to 10% before they bottom.
But if you’re looking to bargain-hunt for stocks with great long-term potential, buying these on the way down could prove very lucrative.
HMOs Take a Plunge
How some major health maintenance organization stocks tumbled late last week on worries that the companies will be severely squeezed on rate increases as more businesses seek to control health care costs.
52-week Price change: Fri. HMO (market) high Thurs. Fri. close FHP International (O) 29 -1 7/8 - 1/2 24 7/8 Foundation Health (N) 44 3/4 -2 1/8 -5 1/2 33 5/8 Intergroup Health (O) 32 3/8 + 1/4 -2 1/2 28 3/4 Oxford Health Plans (O) 61 1/2 -2 1/4 -5 52 PacifiCare Health ‘A’ (O) 57 1/2 -1 3/4 -5 1/4 47 3/4 Qual-Med (O) 22 - 3/4 -1 7/8 17 1/8 Ramsay-HMO Inc. (N) 39 1/4 -2 1/4 -2 3/4 32 1/4 United Amer. Health (N) 21 3/4 - 1/4 -2 16 1/2 United HealthCare (N) 68 -3 1/4 -6 55 7/8 U.S. HealthCare (O) 59 3/4 -2 1/4 -4 1/8 48 3/8 Wellpoint Health (N) 39 3/4 -1 1/2 -3 1/8 33 1/4
Stock HMO (market) P-E FHP International (O) 24 Foundation Health (N) 17 Intergroup Health (O) 21 Oxford Health Plans (O) 57 PacifiCare Health ‘A’ (O) 27 Qual-Med (O) 17 Ramsay-HMO Inc. (N) 24 United Amer. Health (N) 18 United HealthCare (N) 37 U.S. HealthCare (O) 28 Wellpoint Health (N) 18
Stock P-E is price-to-earnings ratio based on most recent 12 months’ earnings per share.
N: New York Stock Exchange; O: NASDAQ
