January 3, 2013 8:11 pm

Healthcare stocks – volatile but attractive

Three complications are worth mentioning

Healthcare stocks are permanent hostages to government policy. This makes owning them labour-intensive. With the state such a big source of revenue, investors easily become entangled in the policy makers’ webs – as if the fundamentals were not hard enough to unravel.

US hospital stocks, though, are starting to look simpler: the shares are cheap, and policy is favourable. The biggest operator by sales, HCA, trades at a single-digit earnings multiple. It has increased profits steadily and throws off ample cash. Bad debt expense – the result of providing services to the uninsured – absorbs almost a 10th of gross revenues. As Obamacare expands insurance coverage in 2014 that number will decline.

Described this way, the story looks as simple as pressing “buy”. Three complications are worth mentioning, however. As the federal budget fight drags on, hospital payments from Medicare (the insurance scheme for the elderly) may be cut. These account for about a third of HCA’s revenues. Secondly, many of the uninsured will be covered via newly-established exchanges on which insurers will offer standardised products. The idea is to create price transparency and competition. Hospital payment levels for these products are still to be determined. JPMorgan reckons that because HCA enjoys excellent reimbursement levels from insurers (a benefit of strong market share in key markets), its industry-leading margins are particularly at risk if exchange products take market share. Finally, there is HCA’s high net debt: 4.5 times earnings before interest, tax, depreciation and amortisation.

All three of these risks mean that HCA shares will be volatile. This could be a boon to those who stay focused on the underlying positives: they can follow the shares closely, and buy the dips. Labour intensive? Sure. But potentially very profitable.

Email the Lex team in confidence at lex@ft.com

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