Anheuser-Busch’s Fizz and PacifiCare’s Vital Signs
Stock Exchange gives readers a chance to listen in as staff writers James Peltz and Michael Hiltzik discuss the merits of individual stocks and other investments.
Anheuser-Busch (BUD)
Mike: Jim, it seems appropriate that our two stocks today are Anheuser-Busch and PacifiCare Health Systems.
Jim: In what way?
Mike: Given how the market’s been the last three weeks, I imagine there are some investors who wouldn’t mind drinking themselves into a stupor and then checking into an HMO.
Jim: Except the HMO would probably give them a cup of coffee and then kick them out to save on costs.
Mike: Easy. Let’s talk about Anheuser-Busch first.
Jim: You know, we often spend half this column just explaining what some companies do because their businesses are so complicated. Not so with Anheuser-Busch. They make beer. Period.
Mike: Yep. As long as the consuming public knows how to open a pop-top can and twist open a bottle cap, Anheuser-Busch has it knocked.
Jim: Anheuser-Busch is the world’s largest brewer, and it has about 45% of the U.S. market. Its flagship brand is Budweiser, home of the talking frogs, and it also sells Bud Light, Michelob and some other brews.
Mike: It’s also got an equity interest in one of the best-selling import beers, Corona, although not distribution-wise.
Jim: Here’s the deal: The beer business has been, well, flat for years because of drooping demand. So the only way Anheuser-Busch could steal market share from, say, Philip Morris’ Miller Brewing unit was to undercut them on price. It was a zero-sum game that was great for suds lovers but bad news for profit and thus for stockholders. Anheuser-Busch’s stock went nowhere for most of 1997, though it managed a 10% gain for the year.
Mike: This year is another story.
Jim: Right. The stock’s been rising steadily this year--at around $56, it’s up 28% year to date--because, flat profit or not, Anheuser-Busch has been grabbing more market share from its rivals. And its stock got a big push recently when the company unveiled plans to hike beer prices by 2% or so. The feeling is they might stick this time and give the company’s earnings a kick. Put it all together, and I’d buy this stock.
Mike: Me, too. One reason they think the higher prices will stick is that the battle for market share means some of the players are going to drop out of sight. That means competition will wane again for Budweiser.
Jim: Good call. The same situation caused a merger wave a decade ago, and took out several brewers. One other thing: Anheuser-Busch’s shares have held up quite well despite the stock market’s problems, which isn’t surprising, because it’s a great defensive stock in times of market turmoil.
Mike: Not to mention in times of global warming.
Jim: I am concerned that if the price hikes don’t stick, the stock will take a hit. But it’s still a good long-term buy.
Mike: I agree. Anheuser-Busch is clearly the victor in the marketing wars, and they’ve managed to hold off all comers, especially Miller, which doesn’t seem able to figure out how to crack Budweiser’s commanding share. In fact, Miller has done things that I find completely inexplicable in terms of positioning their brand.
Jim: Such as?
Mike: Their advertisements that make you wonder whom they’re selling beer to. Not me, that’s for sure.
Jim: Which reminds me of one other thing: Anheuser-Busch has enormous marketing clout. They spend over a half-billion dollars a year in advertising, and, whether you like the frogs or not, that’s a tremendous force in pushing their brands.
JIM: BUY
MIKE: BUY
PacifiCare Health Systems (PHSYB)
Jim: All right, since we’re still of sober mind, let’s move on to PacifiCare. First, this company has two classes of stock, A and B. The B stock seems to be more widely traded, but can you tell us the difference between them?
Mike: Sure: B is the nonvoting class, with about 30 million shares outstanding, versus 8 million Class A voting shares. But from an investor’s standpoint, the shares track each other almost tick for tick.
Jim: And at the moment they’re ticking way up on rumors PacifiCare might be a takeover target.
Mike: They were up 20% at one point yesterday. No one doubts that there’s more consolidation ahead in the health-care industry, but we should look at PacifiCare in terms of its fundamental business--and I don’t like what I see.
Jim: PacifiCare is a big HMO headquartered in Santa Ana--in fact, it’s the largest Medicare HMO in the country. In early 1997 it got even bigger by buying FHP International, another big California HMO. And even though it’s hard to make any sense of the HMO business these days, I would argue that PacifiCare is at the front of the line in terms of performance.
Mike: It’s certainly a good proxy for the HMO business in general, a business I have continuing questions about. Mainly, is the delivery of health care something that’s really appropriate to do in the context of a publicly traded company, given all the pressures and scrutiny that comes with a Wall Street profile? Plus, this is a highly regulated business, but one with stiff competition.
Jim: That’s the crux of the whole debate over HMOs right now. On one side you have doctor groups that want to provide patients the care they think is necessary regardless of the price, and on the other side you have the HMOs who are demanding that the minimum amount of care be given at the cheapest price. What a train wreck.
Mike: Right. You have two forms of discipline that are going to be eternally at odds in this industry. The market discipline pays very close attention to an HMO statistic known as its medical loss ratio. This is the percentage of revenue that is actually spent on delivering health care. Obviously the idea is to keep this as low as possible.
Jim: And PacifiCare’s?
Mike: In the second quarter of 1998, it was 83.7% for the company’s commercial lines, meaning for the policies people buy themselves or through their employers. On Medicare coverage it’s 86%.
Jim: Where does the other 14% go?
Mike: To administrative costs, like paying executive salaries--CEO Alan Hoops received about $1 million last year, which in HMO terms is a pittance--and to profits.
Jim: So the question is whether PacifiCare’s ratio is above the industry average.
Mike: Actually, the question is: How much pressure are they under to get the figure down? And clearly they’re under a lot of pressure and they’re always going to be. HMOs love to claim they’re keeping their loss ratios low by making health care more efficient, but this only raises concerns among patients and doctors that they’re cutting essentials as well. The more HMOs put pressure on costs, the more they do things that raise the ire of regulators and, ultimately, the scrutiny of legislators.
Jim: You’re absolutely right. As long as these companies are publicly held, there will be enormous pressure on them to keep costs down.
Mike: Let’s look at another trend. PacifiCare, like a number of other medical health-care insurers, lately has been able to raise its premiums. After years of holding the line or even getting lower premiums, employers and employer groups are more accommodating. On the other hand, as PacifiCare has raised rates they’ve lost enrollees. Here in California, for example, PacifiCare shed 116,000 enrollees in the year ended in June. That’s 7% of their total California enrollment. And this is a pattern.
Jim: But presumably they’re willing to lose those enrollees to keep the higher-margin business, so they’re not concerned.
Mike: That may be true, but there’s a limit, especially if it turns out that the HMOs are being selective to keep the least-demanding customers--shedding the elderly and chronically ill but keeping the young health nuts. If that develops into a pattern, expect the regulators to start squealing. Plus, it’s going to be a very delicate balancing act to see how far and how high they can raise rates and keep a decent enrollment group, because, of course, the fewer enrollees you have, the more risk you have.
Jim: Meantime, the argument in favor of PacifiCare is that they are close to fully digesting the FHP acquisition. Once they’ve done that they’ll be more efficient and be able to spread their costs over a wider customer base. In fact, their early struggles in digesting FHP depressed the earnings in ‘97, and therefore their earnings in ’98 have improved.
Mike: Although there’s some talk among analysts that one reason their earnings are better is that they’re under-reserved.
Jim: For what?
Mike: For medical claims.
Jim: How could that go against them?
Mike: If it turns out that they haven’t set aside enough money to cover claims that may come in, that would lead to an unpleasant earnings surprise.
Jim: Even so, the stock took off in the first half of this year--going from the mid-$50s to as high as $91--after a poor showing in 1997. Credit goes to the earnings improvement, PacifiCare’s ability to get higher rates and the stock market’s rally. But when the market turned south after mid-July, PacifiCare did even worse and at one point was off some 27% from its peak.
Mike: This seems to me a reflection of great uncertainty about where this company and industry are headed. Nobody is really sure that the improvements in medical loss ratios can be sustained. Nobody is sure about the regulatory environment, and nobody is sure about the rate environment. So I would not buy the stock.
Jim: I would. After dropping so much, PacifiCare is a solid buy now at 19 times its expected 1998 earnings per share--even with all of the uncertainty in the HMO business. Let’s face it: Despite all of the griping and confusion about HMOs, the HMO business isn’t going anywhere. We’re all going to still need medical care and the smart operators will prosper. I put PacifiCare in that group, making its stock a good long-term investment. And the takeover threat is one more kicker to buy it.
JIM: BUY
MIKE: DON’T BUY
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Do you have a stock you would like to see discussed in this column? Michael Hiltzik can be reached at michael.hiltzik@latimes.com; James Peltz can be reached at james.peltz@latimes.com. Or write to either at Business Section, Times Mirror Square, Los Angeles, CA 90053.
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Monthly closes and latests:
Anheuser-Busch Monday: $56.19
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Monthly closes and latests:
PacifiCare Class B Monday: $77.00
