Healthcare Industry

Investor sentiment in healthcare continues to be driven by both Washington and the state of the broader economy.

In late February, President Obama released his administration’s first budget proposal, which included the provision of a $630B reserve fund for healthcare reform over the next 10 years, financed in part by increases in taxes and changes to government program payments for physicians, hospitals and insurers (Medicare Advantage in particular). Details of the measure continue to evolve as discussions continue at the congressional level.

Earlier in February, the $787B economic stimulus package was passed in the Senate and House. The $150B in planned healthcare spending will include $25B towards the expansion of COBRA, $20B for health technology, and $85B for Medicaid assistance to states. The package clearly aims to improve the infrastructure of the healthcare industry and ultimately lower costs and expand access to more Americans.

OPPORTUNITIES

Health technology holds promise of improved operating efficiencies for many parts of the healthcare industry, hospitals included. However, in the short term those that stand to benefit the most from the stimulus are the companies whose business models are based on information technology platforms.

One such company is BioScrip, Inc. (BIOS - Analyst Report), a specialty pharmacy services provider and pharmacy benefit manager. Bioscrip operates two interrelated business segments, namely: Specialty Services, which is comprised of specialty pharmacy distribution and clinical management services; and PBM Services, which is comprised of pharmacy benefit management and traditional mail services. We currently rate the stock of Bioscip a Buy.

Despite our currently neutral stance on managed care providers overall, we continue to rate WellPoint (WLP - Analyst Report) as a Buy given its broad product offering, geographic reach and potential for added synergy gains from relatively recent acquisitions. That said, we believe the recent action by CMS to suspend the company from enrolling new patients in the health insurance Medicare Advantage plan and the prescription drug benefit, Medicare Part D will add to negative sentiment in the short term. We believe the action by CMS is reversible and highlights operational issues that can be addressed by management in the short term.

Another current Buy recommendation is NovaMed Inc. (NOVA - Snapshot Report). NOVA is an emerging healthcare services company engaged in the operation of ambulatory surgery centers (ASCs) and the provision of optical products and services to eye-care professionals. We remain positive with the company's performance to date, given the continued strength of cash flows from operations and same facility revenue growth.

WEAKNESSES

Medicaid-focused managed care providers are, to some degree, countercyclical and often perform well in mild recessions. However, and despite the $85B allocated to Medicaid in the stimulus, we remain cautious at this point, given the severity of the current economic downturn and uncertainties surrounding healthcare reform. Unlike other managed care players, Medicaid managed-care companies are highly reliant on funding from state governments, which in turn are subject to budgetary constraints and policy changes at the federal level.

We expect hospitals to gain some relief from the $15B in Medicaid assistance earmarked for immediate distribution to help close budget gaps coupled with the expansion of COBRA. COBRA provides temporary continuation of health coverage in the event of a job loss.

However, we believe the hospital sector will remain under pressure for the remainder of 2009 given anticipated lower consumer spending, high unemployment, and shifts in payer mix further already weakening 4Q08 admission numbers and increasing bad debt levels. We note that hospitals by law must treat all patients in need of emergency care, regardless of whether they have insurance.

We currently rate both Community Health Systems (CYH - Analyst Report) and Universal Health Services, Inc. (UHS - Analyst Report) with Hold recommendations.