Health-Care Stocks with Legs


By Sam Stovall By all appearances, lots of investors have been checking into health-care facilities -- the shares of the outfits that run them, that is. Standard & Poor's health-care facilities subindustry index has surged 21.7% year-to-date through Apr. 8, vs. a 2.4% decline for the S&P 1500-stock index, after underperforming the overall market in 2004. This group, which features a relatively high average S&P STARS ranking, comprises 15 companies, the majority of which provide hospital management and long-term-care services.

The group's high momentum is apparent from its relative strength chart, shown below. As a reminder, the jagged blue line represents the subindustry index' rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index' 14-year mean relative strength.

The question we ask is: What will keep this group's head above water in 2005 after such a strong start this year? Analyst Cameron Lavey, who follows the sector for S&P Equity Research Services, maintains a positive outlook, reflecting what S&P sees as improving fundamentals in the hospital industry.

FUELING REVENUE GROWTH. Looking at segments within the subindustry, Lavey has a neutral outlook for long-term-care facilities, as he anticipates positive demographic trends will be offset by potential Medicaid reimbursement cuts. Medicare legislation passed in December, 2003, offers higher pricing for both rural and urban hospitals in 2005. S&P expects the negative effects of a rising number of uninsured patients and higher insurance co-payments to moderate after trending up for most of 2004.

As for the acute-care hospitals, Lavey's outlook is positive. Overall, S&P expects low volume growth, mid- to high-single-digit price increases from managed care, and higher Medicare reimbursement rates to fuel revenue growth. In addition, Lavey thinks recent trends in bad-debt expense, as well as in labor and supply costs, point to improving operating conditions within the industry.

Lavey believes Medicare and managed-care reimbursement rate increases should continue to drive growth for acute-care hospitals for the near term, but he's less optimistic with respect to Medicaid. State budget problems could hurt Medicaid reimbursement, in S&P's view. However, Medicaid generally represents a relatively small portion of total hospital revenue.

COMPETITIVE THREAT. For long-term care, S&P remains neutral about industry operating trends. Lavey thinks revenue growth prospects in the hospital sector have been helped by a favorable private pricing environment that began in late 2003. Labor and supply costs, as well as malpractice expense, appear to be stabilizing and could begin to trend down, in S&P's view.

While Lavey thinks competition from specialty hospitals poses a competitive threat to general acute-care operators, he thinks the moratorium on new specialty facilities should help offset this challenge. On average, S&P estimates that high-single-digit revenue growth in 2005 should drive earnings-per-share gains of 10% to 12% for acute-care outfits. Given S&P's view of attractive valuations, Lavey expects investor capital to flow to the acute-care group.

So there you have it. From both a fundamental and momentum standpoint, S&P believes investment opportunities exist for the health-care facilities group over the next 12 months. Lavey's top picks among the stocks he covers are Community Health Systems (CYH

; recent price, $36) and Triad Hospitals (TRI

; $51), both ranked 5 STARS, or strong buy. At the other end of the spectrum, he ranks Tenet Healthcare (THC

; $12) 2 STARS, or sell.

Industry Momentum List Update

For regular readers of the Sector Watch column, here's this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), their proxies (the highest STARS-ranked companies in the subindustry index -- tie goes to the largest market value) as of Apr. 8.

Industry

Company

Ticker

S&P STARS Rank

Recent Price

Commodity Chemicals

Lyondell Chemical

LYO

3

$27

Distillers & Vintners

Brown-Forman

BF.B

5

$55

Drug Retail

CVS

CVS

5

$52

Fertilizers & Agr. Chem.

Scotts Co.

SMG

4

$68

Homebuilding

Lennar

LEN

5

$57

Integrated Oil & Gas

ExxonMobil

XOM

5

$60

Managed Health Care

PacifiCare

PHS

5

$58

Oil & Gas Drilling

Nabors Industries

NBR

5

$58

Oil & Gas E&P

Devon Energy

DVN

5

$47

Oil & Gas Refg., Mktg. & Trans.

Valero Energy

VLO

4

$77

Railroads

Burlington-Northern

BNI

5

$52

Steel

Carpenter Technology

CRS

4

$62

Required Disclosures

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of March 31, 2005, SPIAS and their U.S. research analysts have recommended 30.9% of issuers with buy recommendations, 56.6% with hold recommendations and 12.5% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041.

Other Disclosures

This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS.

Disclaimers

This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Stovall is chief investment strategist for Standard & Poor's


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