The Health Care Monster, 2: Investment Opportunities

Copyright © 2009, Greenwich Financial Management Inc., a registered investment advisor.

With the entire Obama health care agenda up for grabs in Congress at this time, it may seem reckless to invest in the health care industry. President Obama has been jawboning and making deals to contain costs, and Congress is anxious to clamp down on runaway budget expenses in medicine. However, some very good values are showing up in this sector, and there are at least fourth good reasons to take a more sanguine view. First, the overall effect of reform will probably be to increase federal spending on health care, and this probably will translate into greater total health care spending—that is to say, demand for medical care, services, medicine and equipment. Second, any reform that comes out of Congress will look more like what we already have than many—particularly on the Right—fear. Third, there is a wide dispersion in quality and value across this sector, and therefore good room for intelligent stock-picking. Fourth, if reform fails in Congress, there is also upside, similar to the scenario that brought up many health care stocks in the wake of the Clinton’s Administrations failed effort.

In medical equipment, Texas-based Kinetic Concepts Inc. (“KCI,” $33.16) is attractive. (all prices quoted as of market close 8/11/2009; data source is Yahoo Finance). KCI is involved broadly speaking in tissue care, including wound healing, cardio-vascular complications, regenerative medicine (soft tissue repair and replacement) and bariatric (obesity prevention and treatment). Its market capitalization is about $2.35 billion. Its price to earnings ratio for the trailing twelve months is 11.27 times and its expected price to expected earnings ratio for 2010 is a mere 7.76 times. Its operational performance shows good momentum. Its PEG ratio (ratio of price per share to 5 year expected earnings growth, as measured by Wall Street analysts; a measure of long-term value in relation to growth) is only 0.84, where a number below 1.0. Return on equity, a measure that reflects partly on management quality, is a healthy 23.24%.

Industry giant Humana (“HUM,” NYSE, $34.40) offers supplemental health and accident insurance benefit plans to various classes of customers, including government, corporations and individuals. The so-called government segment includes a large Medicare Plus gap insurance program. HUM appears to be quite attractive from a value perspective. The company is potentially vulnerable to adverse affects from health care reform from several angles, which could possibly reduce revenues or operating margins in some of these segments. However, Humana has been on trend of beating analyst expectations and is a well-managed company.

In the biotech sector, a promising candidate is Biogen Idec (“BIIB,” $47.93). BIIB has a number of products in the market currently, including Avonex and Tysabri (for treatment of multiple sclerosis), Rixutan (for certain forms of non-Hodgkins Lymphoma) and Fumaderm (for psoriasis). It also has a rather full pipeline of drugs under development, a number of which are in advanced stages (II or III) of the approval process with the Food and Drug Administration (FDA). It is trading currently at about 17 times trailing earnings and 11 times forward earnings for 2010.

Note: Clients advised by Greenwich Financial Management Inc. may hold long or short positions in securities mentioned in this article or in derivatives of those securities. The author of this report has no personal holdings or interest in the referenced investments and has received no compensation for providing the above research from any of the listed companies. The information is not sufficient by itself to make an investment decision. The suitability of such investments for particular individuals has not been assessed.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.

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