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Health Care


Product companies out. Service companies in. That's the prescription for health-care investing these days. It also reverses a long-term trend. Until recently, stocks of biotech, drug, and medical-device companies sold like crazy, reflecting patient demand for the latest treatments, no matter how costly. That was bad news for hospitals and insurers--investors shunned those stocks. Now, HMOs and hospitals are on the rebound, sticking double-digit price increases to their customers, many of them large companies that offer their staff medical insurance.

Meantime, pharmaceutical and biotech product pipelines are drying up, making blockbuster treatments less likely anytime soon. Aside from a few out-of-favor but promising drug stocks, "the services stocks will continue to outperform product-based companies," says Jon M. Fisher, head of equity research at Fifth Third Bank in Cincinnati. Demographics support that trend. Norman M. Fidel, health-care portfolio manager at Alliance Capital Management, says an aging population should drive hospital admissions as insurance reimbursement rates rise--in some cases by nearly 10%.

Fidel likes rural hospital operator Health Management Associates (HMA), based in Naples, Fla. Alliance held almost 30 million shares of HMA as of Mar. 31. It has a reputation for quality care and a low debt-to-capital ratio. The company could benefit from efforts in Congress to boost Medicare reimbursement for rural hospitals. Analysts say the stock is relatively cheap at a price-earnings ratio of 18.6 based on expected 2003 earnings. "The fundamentals [for hospitals] are the best in 15 to 20 years," says Fidel.

Managed-care companies and insurers also have the wind at their backs. Fifth Third's Fisher likes Anthem (ATH), a BlueCross BlueShield operator that recently went public. He figures the company can boost margins and make some acquisitions. He also sees Anthem as cheap at about 16 times projected 2003 earnings. He figures its p-e should be least 18.

There are also ways to profit from big drugmakers' pain. According to SG Cowen Securities, from 2002 to 2005, drugs with $30 billion in U.S. sales will lose patent protection or other forms of market exclusivity--great news for generic drugmakers.

Jon D. Stephenson, an analyst at State Street Research & Management, likes generic drugmaker Barr Laboratories (BRL). The company has focused on products that attract fewer rivals. For example, oral contraceptives haven't lured many generic players because it's difficult to obtain the raw materials and manufacture the pills. But by June 30, the end of its fiscal year, Barr expects to offer nine oral contraceptives. The stock trades at 14 times 2003 earnings estimates--vs. about 15 for the industry, yet CIBC World Markets analyst Elliot Wilbur believes Barr's 2003 p-e should be about 25.

Of course, some branded drugs continue to grow at a healthy clip, especially biotech-based drugs which, for regulatory and manufacturing reasons, have attracted few generic competitors. Medical-products company Baxter International (BAX) is on a tear thanks to a product for hemophiliacs called Recombinate. Merrill Lynch analyst Daniel T. Lemaitre thinks it will provide some 40% of Baxter's earnings growth over the next few years. Although earnings growth will hit the high teens in that period, Baxter's p-e ratio, based on 2003 projected earnings, is just 21. Lemaitre thinks it should be well over 25. "This a product that will transform the company," he argues. And possibly the portfolios of some savvy investors. By Amy Barrett


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