Home Front: Anthrax Scare Could Make Hospital Shares Healthy

That likely won't be true for health insurers, whose profits can be hurt by a rise in unhealthy HMO participants.
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Editor's note: This is the fourth installment in TheStreet.com's Home Front series, a collection of twice-weekly features that examines how American business, society and investing have changed in the post-Sept. 11 landscape.

Anxieties accompanying the spread of anthrax will cause an increasing number of people to seek medical advice, analysts predict.

"Each and every day we find a new group potentially affected," said Sheryl Skolnick, a health care industry analyst with Fulcrum Global Partners, a New York-based brokerage. "You don't know if people are panicking or being prudent."

Indeed, daily news about anthrax cases is multiplying fears. People are seeking professional diagnoses for various ill feelings. Many false scares originate from symptoms caused by inhaled anthrax -- body ache, fever and fatigue also are common to influenza, whose prime season is approaching.

But not every company in the health industry will see a spike in profits from the uptick in demand for diagnoses. The stocks of health insurers may be poor bets. Better returns could come from hospital shares.

No Assurances in Insurance

As investment opportunities, hospitals fare better because their fixed costs generate profits from every transaction. Say an aspirin costs a hospital 10 cents and it sells the aspirin for 15 cents, making 5 cents on every one sold. The more aspirin sold, the more money a hospital makes. In other words, the greater number of people a hospital treats, the more revenue it earns.

Health insurance companies, on the other hand, don't always see a profit with every transaction. In fact, some surgeries, prescriptions and treatments result in a loss for health insurers, whose clients pay a small co-payment and pass along the bulk of the cost to the insurer.

"HMOs only want healthy people," said Skolnick. "Their perfect customer is someone who doesn't get sick." Healthy participants offset costs by paying high premiums without using their benefits. Insurance companies see substantial profits only when the premiums of healthy participants outweigh the costs from the unhealthy who submit bills. Thus, more doctor visits don't necessarily mean more money for an insurer.

To make matters worse, the slowing economy and increasing layoffs will leave more people without health insurance. To counteract the loss of people, insurance companies are charging higher premiums. A recent study from Hewitt Associates, a human resources consulting firm, said that health care insurance premiums are expected to rise between 13% and 18%, depending on the type of plan. At the same time, however, an increasing number of healthy people are using their insurance to check for anthrax contamination and possibly offsetting any profits the extra money from premiums might produce.

Investing in Hospitals

Even before Sept. 11 and the anthrax fears, hospital visits were on the rise. According to information provided by

Tenet Health Care

(THC) - Get Report

, a chain of 110 hospitals in 17 states, hospital admissions rose an average of 3.6% during fiscal 2001, nearly double the average gain in admissions during 1998 to 2001. Similarly, rival

HCA

(HCA) - Get Report

recently announced that visits to hospitals open at least a year were up 2.6% in the third quarter from the same period a year ago.

"There is a bubble of people who are aging, and as they age, they use more health services per year," said Samuel Levitt, a hospital analyst with Fox-Pitt, Kelton, an investment bank.

On Thursday, Levitt upgraded the hospital giant HCA from attractive to buy with a one-year price target of $51, a 29% upside from Thursday's closing price of $39.60. "It's a great deal at these levels," he said.

Although the government has accused HCA of overcharging on certain procedures, Levitt said that the company's position as the market capitalization leader outweighs any risk caused by the dispute. "If the industry is doing well, then HCA is doing well," Levitt says.

Levitt also likes

Health Management Associates

(HMA)

, which he gave a buy rating and a one-year price target of $25, a 26% upside from Thursday's closing price of $19.87. HMA trades at 21 times 2002 estimated earnings.

"Hospital stocks were undervalued," he said. "And when the tech sector stopped working, people noticed the improving fundamentals and the stocks took off. But are you overpaying for a good story?"

Skolnick doesn't think so. Her top pick would be Tenet because the company has geographic diversity, some of the best hospitals in their areas and no disputes with the government. She believes Tenet's stock will rise to $72 in the next 52 weeks and that $62 is a "reasonable price" to dip into the stock. The stock finished on Thursday at $57.42. In her opinion, Tenet is undervalued at these levels, trading at 20 times 2002 estimated earnings.

On the small-cap front, she likes

Provence Healthcare

(PRHC)

because it is a small rural chain growing at a fast pace with little competition. Province's stock ended Thursday's session at $27.80, or 22 times 2002 estimated earnings.

"Hey, if you can be a monopolist, so much the better," she said.