Strategy
Lower growth, higher uncertainty -> lower stock valuation
We have reduced our revenue and income growth rate outlook for health
care provider stocks a notch to reflect what we believe to be lower
growth prospects and heightened uncertainty due to several (mainly
external) factors.
These are:
1) continuing and possibly worsening employment weakness. As
noted before, employment still is directly related to level of
commercial health insurance coverage. Lack of patient income also is
directly related to growth of hospitals' bad debt expense.
2) ACOs: A fairly high level of uncertainty exists around which
providers and patients can and will participate in accountable care
organizations under health care reform. Participant providers are likely
to incur significant startup costs and may become eligible to share in
cost savings that inure under the program. Providers may gain or lose
patients depending on how ACOs are structured in final form.
3) The trend toward more extensive physician employment by provider
organizations continues its multi-year trend, and may be accelerating as
government puts increasing downward pressure on reimbursement. Physician
employees tend to increase salary and benefit expenses for these
companies in early years. These expenses may eventually be offset by
higher revenue or reduced costs in other areas.
Things are not that good yet
HMA
With many companies' (including health care providers') operating results improving over the past year, and expected to continue to improve (although not at such a blazing pace off the bottom) this year, you may well wonder why many stocks now seem to be banging their heads against resistance.
Two major indexes, the Dow and S&P 500, have picked big round numbers around which to stall out: For the Dow, 12,000, and for the S&P, 1300. These numbers are convenient but not particularly significant.
What matters more, in our view, is that while economic and company fundamental conditions appear to be broadly improving, things are not that good. Sector-wise, industrials and materials are strong, consumer sectors are improving, but financial and housing related areas are still weak and lack catalysts for improvement. Employment growth is anemic. Political forces are more evenly balanced, which has made the political scene more dynamic and less predictable than before. Many business growth, fiscal and tax issues remain unresolved and have become more urgent than before.
Also, looking at the charts below, it's evident that the health care provider stocks at least have fully recovered from long recessionary slumps. But the new normal is not like the old normal. While companies may have cleaned up their balance sheets over the past two years, the environment in which they operate--the US economy--has increased debt and risk to an unprecedented level, and that will be reflected in the valuations of companies like health care providers that operate mainly in the US. We therefore expect valuation multiples for the health care provider group to continue to be lower than their long term averages.
Two major indexes, the Dow and S&P 500, have picked big round numbers around which to stall out: For the Dow, 12,000, and for the S&P, 1300. These numbers are convenient but not particularly significant.
What matters more, in our view, is that while economic and company fundamental conditions appear to be broadly improving, things are not that good. Sector-wise, industrials and materials are strong, consumer sectors are improving, but financial and housing related areas are still weak and lack catalysts for improvement. Employment growth is anemic. Political forces are more evenly balanced, which has made the political scene more dynamic and less predictable than before. Many business growth, fiscal and tax issues remain unresolved and have become more urgent than before.
Also, looking at the charts below, it's evident that the health care provider stocks at least have fully recovered from long recessionary slumps. But the new normal is not like the old normal. While companies may have cleaned up their balance sheets over the past two years, the environment in which they operate--the US economy--has increased debt and risk to an unprecedented level, and that will be reflected in the valuations of companies like health care providers that operate mainly in the US. We therefore expect valuation multiples for the health care provider group to continue to be lower than their long term averages.
CYH
UHS
THC
Will market anticipate end of Obama Discount?
We believe that one factor that has contributed to generalized securities market weakness in past months is heightened domestic political uncertainty for US stock following legislative and regulatory actions of the Obama Administration. Much of the effect is expected to be felt in the financial and health care areas due to legislation and regulation that directly affect those sectors. However, the wider ramifications of regulation and tax actions affect a broader range of industries and sectors, with the main effect being increased costs and restraint of investment by these sectors. We further believe, with other observers, that this results in a lower price multiple for issues in most industries (the Obama Discount).
With the approach of mid-term elections and anticipated shifting of many seats in the Senate and House from Democratic control to a larger percentage of Republicans, we believe market participants expect slowing of the high-spending legislative and regulatory trend. This should at some point be reflected in a lessening of the Obama Discount and more normalized securities multiples.
While we do not expect a complete retracement of price multiples this year, we believe that depending on the extent of Republican victories in November, investors may anticipate a more complete turn from Democratic policies in 2012. If that is the case, we would anticipate a further recovery of more normalized valuation multiples over the next 12-18 months.
With the approach of mid-term elections and anticipated shifting of many seats in the Senate and House from Democratic control to a larger percentage of Republicans, we believe market participants expect slowing of the high-spending legislative and regulatory trend. This should at some point be reflected in a lessening of the Obama Discount and more normalized securities multiples.
While we do not expect a complete retracement of price multiples this year, we believe that depending on the extent of Republican victories in November, investors may anticipate a more complete turn from Democratic policies in 2012. If that is the case, we would anticipate a further recovery of more normalized valuation multiples over the next 12-18 months.
QE2 and effects of money on markets
With the Dow approaching 11,000 and S&P above 1150, we are refreshing our outlook on the broader markets, which have a greater than average effect on the direction of individual stock prices right now.
We believe it is especially important now to keep in mind that the US and other major industrial countries are contemplating or are involved in the second phase of what is know as quantitative easing policies (QE2) designed to reinflate flagging economies. This policy entails increasing reserves in banking systems to increase the money supply when, as now, it is hardly possible to lower interest rates any further. The added supply of money, or anticipation of that, is causing the value of the dollar to fall (see blue jagged line of chart--the one that is plunging on the right side).
In turn, the prices of US stocks, denominated in dollars, rises--although not for any reason related to actions of companies issuing the stock. The value of the dollar is of course just one factor in the price trend of stocks. At this juncture, however, it is a large and determining one that we believe will remain in place for some time, on the order of the next 12-18 months.
We believe it is especially important now to keep in mind that the US and other major industrial countries are contemplating or are involved in the second phase of what is know as quantitative easing policies (QE2) designed to reinflate flagging economies. This policy entails increasing reserves in banking systems to increase the money supply when, as now, it is hardly possible to lower interest rates any further. The added supply of money, or anticipation of that, is causing the value of the dollar to fall (see blue jagged line of chart--the one that is plunging on the right side).
In turn, the prices of US stocks, denominated in dollars, rises--although not for any reason related to actions of companies issuing the stock. The value of the dollar is of course just one factor in the price trend of stocks. At this juncture, however, it is a large and determining one that we believe will remain in place for some time, on the order of the next 12-18 months.
Markets: Extended retracement
We had been waiting for the Dow to work its way back from 9000 through 11,000 since late 2008. This average seems to have begun to break through resistant right below 11,000, after a fairly steady advance to 10,000.
moving through resistance?
Progress was similar for the S&P 500's move back from 950 back toward 1,200, which has now passed resistance at 1,150. Many companies when reporting year-end 2009 earnings noted cautious outlooks for the first half of 2010. Currency issues and a possible double dip in world economies, especially in Europe, had up to recent weeks cut upward market momentum and increased volatility.
Health care stocks have retraced further
Health care stocks (chart is S&P healthcare index over the past 2 years) more completely retraced their drop since the fall of 2008, but like the broader indexes, show some resistance to moving on further. In addition, increased concern with reducing the cost of government funding programs including health care had led us to the opinion that regulatory risk is increasing for health care stocks among those in other sectors. Despite these lower valuation criteria, health care stock valuations appeared to be relatively cheap.
This is not to disparage continuing strong operating and financial fundamentals for many health care provider companies. The weak economy depressed discretionary spending for non-emergency care, and patient volumes were affected by that trend. Also, higher joblessness caused loss of employment-related health insurance. Health care providers responded by focusing on physician recruitment and emergency care. They also became much more adept at aiding patients in qualifying for government health coverage, reducing the effects of joblessness on uncompensated care and bad debt. Nimbler management aided these companies in producing year over year increases in earnings through the recession, for the most part, and continues to work for them as the economy recovers.
As we have said before, hospital companies and a number of other providers have assumed no positive contributions from federal health care reform, due largely to lack of visibility on this program. Health care reform news may prompt some short term volatility in these stocks, but is less tightly linked to their longer term outlook. Looking out several years, health care providers now see incremental patient volume gains. But since the anticipated new patients for the most part have been uninsured before, cost of treating them may be high and the expense side of the new patient volume is less than clear.
This is not to disparage continuing strong operating and financial fundamentals for many health care provider companies. The weak economy depressed discretionary spending for non-emergency care, and patient volumes were affected by that trend. Also, higher joblessness caused loss of employment-related health insurance. Health care providers responded by focusing on physician recruitment and emergency care. They also became much more adept at aiding patients in qualifying for government health coverage, reducing the effects of joblessness on uncompensated care and bad debt. Nimbler management aided these companies in producing year over year increases in earnings through the recession, for the most part, and continues to work for them as the economy recovers.
As we have said before, hospital companies and a number of other providers have assumed no positive contributions from federal health care reform, due largely to lack of visibility on this program. Health care reform news may prompt some short term volatility in these stocks, but is less tightly linked to their longer term outlook. Looking out several years, health care providers now see incremental patient volume gains. But since the anticipated new patients for the most part have been uninsured before, cost of treating them may be high and the expense side of the new patient volume is less than clear.
