Solid premiums are expected to result in solid earnings for the managed care group this year, and that could translate into healthy price gains if investors are selective, some analysts say.
Managed care stocks declined by about 9% last year as measured by the Morgan Stanley HMO index, outperforming the
, which fell 13%. The group has benefited from perceptions that it is a defensive play, but given expected double-digit earnings expansion in 2002, some of these stocks could act more like cyclicals.
"The industry is in great shape," noted David Shove, an analyst atPrudential Securities. "Premiums are stronger than they have been in quitea while because Americans are placing greater value on health insurance andsecurity than they were a few months ago and medical costs are expected tofall off slightly from recessionary levels."
which reaffirmed 2002 earnings guidance on Thursday and is a favorite among some analysts, rose almost 4% to $119.50 onFriday. The company is currently about $3 below its 52-week high but trades at just 16.6 times projected 2002 earnings. Recent IPO
closed Friday at $47.85, about $4 below its 52-week high but just 13.75 times 2002 earnings. Meanwhile,
trades for $70, about $8 below its 52-week high and at 21.4 times projected 2002 earnings.
Some companies in the group face bigger obstacles than others. Several health insurers have been plagued by rising medical costs over the past year. Because many insurers negotiate premiums months in advance, companies tend to be exposed if medical costs rise faster than expected.
PacifiCare Health Systems
( PHSY) is one company that has had trouble getting its cost structure in line. The firm announced a major reorganization Thursday, saying it would eliminate about 1,300 jobs, or 15% of its workforce, in order to produce annual savings of $80 million to $90 million.
announced last month that it would slash 6,000 positions, or 16% of its workforce. And
said late last year that it would cut 1,500 positions.
Analysts say the outlook for these companies remains murky.PacifiCare's earnings visibility is still low at this time and cost-cuttingmeasures at Aetna aren't expected to reap rewards until the second half of theyear. Still, prospects for the rest of the industry are much brighter.
"Some companies' costs got out of whack but margins have actuallyexpanded for the overall group over the past few years," said John Szabo,an analyst at CIBC World Markets. "Pricing power is very strong."
Most managed care companies either met or exceeded earnings estimatesin the third quarter thanks to higher premiums and some analysts believethe trend will continue into 2002.
"The increase in premiums should more than offset rising medicalcosts," said Robert Mains, an analyst at Advest. "A 12% to 13% rateincrease gives them some wiggle room."
ABN Amro analyst Peter Costa believes costs will actually be lowerthan anticipated this year because prescription drug prices will come underpressure from generic competition. That should also give insurers a boost.
One concern has been that membership in health care plans will declineas unemployment rises. The latest report showed that unemployment jumped to5.8% in December -- the highest level since April 1995.
"If the economy does go into a tailspin, there could be a decrease inoverall enrollment," said Mains. In addition, he noted that when peoplelose their jobs and take on temporary coverage through Cobra, they tend touse health care services 50% more than if they were in other health plans,which is more costly for insurers.
Still, other analysts believe an increase in unemployment should haveminimal effect.
"Earnings are driven by profit margins, not by enrollments," said Szabo,adding that a 1% or 2% rise in the unemployment rate and a comparable loss inmembership can be easily made up by premium increases or by watering downbenefits packages to employers.
With an economic recovery looming, it's possible the group will suffer as investors look for growth elsewhere. "The group has held up better because it was viewed defensively," said Steve O'Neil, analyst at Hilliard & Lyons. "An economic recovery could mean rotation into more economically sensitive stocks."
But many analysts argue that HMO stocks are much less defensive than other segments of the health care industry and will not be negatively affected by a turnaround in the economy. "It's more cyclical than people think," noted Mains.
Analysts are looking for earnings growth of about 12% to 15% from thegroup this year while the S&P 500 is expected to see growth of around 5%,according to First Call. The sector also trades at a discount to thebroader market at about 15 times forward earnings compared to 25.1 for theS&P 500.
"The problems some companies are seeing are specific to those firms butthe industry trends are still pretty strong," Costa said.