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Healthcare

U.S. Healthcare Reform is a Big Boon For Healthcare Companies

On March 23, 2010 President Barack Obama signed the historic healthcare reform bill into law. This marked the end of many months of wrangling between the Republicans and Democrats. The $938 Billion bill brings many significant changes to the US healthcare system in decades.

The $938B bill would be financed by tax increases and reduction in Medicare spending according to the Congressional Budget Office(CBO). CBO also predicts that the federal deficit would be reduced by $143 billion in the first 10 years. The bill would also extend heath insurance to 32 million uninsured Americans.

From an EPI article :

“Under the new law, the portion of Americans with health insurance coverage will rise to 92% by the year 2016 and remain steady at that level in future years.  As a result, the number of Americans with no health insurance will fall from 50 million today, to about 23 million in 2019, even as the population grows.”

Some of the obvious beneficiaries of this new law are companies related to the healthcare sector such as health insurers, drug companies, hospitals, medical device makers, etc. Though many provisions of the healthcare reform bill does not become effective immediately, these companies stand to benefit from higher business growth over the next few years.

From an investment standpoint, the stocks of US drug makers looks cheap now according to a piece in Moneyweek.

Source: Bloomberg via Moneyweek

US drug stocks are very cheap for the following reasons:

1. Investors’ worries about sales collapse due to expiration of patents on blockbuster drugs are overdone and are already priced into stock prices.

2. As the EPS of the pharma sector went up over the past few years, the P/E has been dropping steadily as investors withdrew from this sector. The P/E fell from over 90 in 1999 to about 11.5 now. Also the S&P Pharma index is down 10% lower than where it was 12 year ago.

3. Unlike the EPS growth of S&P 50, the drug companies have been growing their profits at a consistent pace over the last 12 years.

4. The new law will not set any government price controls and additional regulations will not be imposed on drugs industry.

5. Prescription drug prices are 30-50% higher in the U.S. compared to other OECD countries (Source: Disparities in health expenditure across OECD countries:
Why does the United States spend so much more than other countries?, OECD )

The complete list of drug stocks trading in the NYSE can be found here

Health insurers will benefit due to the following reasons:

1. Additional 32 million Americans will be required to purchase insurance.

2. New restrictions such as the placing of lifetime limits on coverage or denying adults based on pre-existing conditions will not become effective until 2014.

3. Many insurers are expected to raise premiums in order to maintain profits. Recently Anthem Blue Cross raised premiums by as much 39% in California for some customers.

4. Some insurance companies will go out of business since they would not be able to compete under the new regulatory environment and others  may merge with the big players leading to a bigger consolidation in the industry.

The five largest health insurers in this country are Aetna(AET), Cigna(CI), Humana (HUM), UnitedHealth Group(UNH) and Wellpoint(WLP).

Medical device makers and healthcare facilities also stand to profit from this new legislation since in general more medical procedures are performed in the U.S. than other OECD countries as the table shows below.Many of the diagnostic tests such as MRI are very expensive and are done even when not required as part of the “defensive medicine” strategy followed by healthcare professionals. Threat of lawsuits forces doctors to perform unnecessary tests generating billions of dollars in revenue for hospitals, medical diagnostic companies and others. Hence it is not surprising to see that the US also has the highest number of MRI units and CT scanners in the world after Japan.

NYSE-listed stocks of Medical Equipment makers, healthcare facilities and biotech & Drug makers can be found here and here and here.

Drug Stocks Offer Long-Term Investment Opportunities

In  a recent article I wrote that U.S. public healthcare spending is projected to exceed private spending by 2012. U.S. healthcare expenditures was estimated to reach about 17.3% of the GDP in 2009. One of the beneficiaries of all this spending are the companies in the healthcare industry such drug makers, health insurers, etc. They all may perform well in the coming years.

The table below lists the major drug stocks trading on the NYSE:

AstraZeneca plc, GlaxoSmithKline plc, Novartis AG and Tongjitang Chinese Medicines Co. are the four foreign drug companies in the list. U.K-based AstraZeneca (AZN) is the owner of many top selling drugs including the “purple pill” Nexium which is used for the treatment of Gastroesophageal reflux disease (GERD). Currently AZN offers a 7.75% dividend yield. GlaxoSmithKline (GSK) is another British giant whose products are sold in over 150 countries. GSK pays a 6.02% dividend. Switzerland-based Novartis(NVS) had sales of over $45B last year.Tongjitang Chinese Medicines Co (TCM) is a specialty drug company that is engaged in the manufacture of modernized traditional Chinese medicine.

Among the U.S. companies, Johnson and Johnson(JNJ) is by far the largest maker of a wide range of healthcare products. JNJ was founded in 1886. The stock is a high quality long-term consistent performer. Form JNJ’s investor site:

“Our consistent performance has enabled us to deliver an exceptional track record of growth that few, if any, companies can claim: 76 consecutive years of sales increases; 25 consecutive years of adjusted earnings increases; and 47 consecutive years of dividend increases. Over the last 10 years, Johnson & Johnson stock generated a 5.6 percent total return for investors compared to a -1.4 percent total return for the S&P 500.”

U.S. Public Healthcare Spending To Exceed Private Spending

The U.S. spends the highest amount for healthcare on a per-capita basis than other OECD member countries. Soaring health care costs continue to be a major concern for ordinary Americans.

In Public Health Tab to Hit Milestone, The Wall Street Journal notes that “For the first time, government programs next year will account for more than half of all U.S. health-care spending, federal actuaries predict, as the weak economy sends more people into Medicaid and slows growth of private insurance.”

Public spending accounted for 47% of the total health-care spending in 2008. Federal actuaries had predicted earlier that the government spending would cross the 50% mark by 2016. However they now predict that by 2012 public spending would exceed 50%.

Chart:

The main reasons for the rise in public health spending are:

• The economic recession
• Rising unemployment
• Changing demographics
• Baby-boomers retiring

The U.S. total heath care expenditures was estimated to reach $2.5T in 2009 accounting for 17.3% of GDP. Despite the decline in GDP health-care spending rose by 5.7% last year. Health-care spending is projected to increase to $4.5T in a decade.  As the number of unemployed people increases, they lose their private health-care benefits and some try to enroll into the Medicare and Medicaid. This is causing a rise in enrollments in those public programs.The Medicare program for poor people is projected to see a 5.6% rise in enrollments this year. Last year medicare expenses are estimated to have reached a whopping$507B.

Enrollments in private health-care plans is estimated to decline again this year due to the continued high unemployment levels and expiration of subsidies for the COBRA plan.

Sluggish growth in the job market, stagnant/declining wages in the private sector and rising health-care costs do not bode well for the future of U.S. economy.