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Health Insurance Industry Stock Outlook - Sept. 2017

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More than 8 months have passed since the Trump administration took the reins at the White House. This was a major political development that many saw as particularly consequential for the health care industry, given the GOP’s ‘repeal & replace’ demand.

Notwithstanding the priority afforded to the ‘repeal & replace’ effort, the administration wasn’t able to push a new measure through Congress on the first try and the odds of the second effort succeeding this week through the Graham-Cassidy bill also appear slim.

One would think that this policy uncertainty should have been drag on the health insurer stocks, but you would be hard pressed to see that in the industry’s stock market performance this year. Since the November election, the Zacks HMO industry stocks are up +36.1%, more than double the S&P 500 index’s +16.5% gain.

We shall see how the latest congressional effort through the Graham-Cassidy bill pans out in the next few days, but it appears that market participants had a better sense of the success of the ‘repeal & replace’ effort than the politicians did.

The industry, however, has witnessed the failure of some high-profile mergers. Other factors that weigh on the sector were losses from public exchange business, soft commercial insurance volume, increasing competition, increased expenses in the form of higher spending on innovation and technology.

Nevertheless, the industry remained an outperformer by growing 24% year to date, outperforming the S&P 500 index’s 12% gain.

The industry was mired in a nasty regulatory web after the passage of the Affordable Care Act (ACA, aka “Obamacare”) in 2010. Let’s see to what extent this historic event has influenced the industry.

Was Health Reform a Blockage at All?

The industry is continuing with its bull run despite a pull-back mostly in the form of stringent regulations which hampered the industry (post-ACA passage). Revenues across the industry have been growing consistently, driving bottom-line growth.

The performance of health insurance stocks since ACA doesn’t show any unusual weakness. In fact, the industry performed better than the broader market during this period, indicating its ability to adapt to the changing landscape. Since the reform came into being, the industry has rallied 340.3%, versus 117.8% growth in the S&P 500 overall.

What Made This Outperformance Possible?

In a highly regulated environment, insurers modified their business strategies to deal with the changes that the law brought along. Moving beyond their domestic business domain to international shores aimed at growing part of their business (which would be outside the realm of ardent regulations at home) was a wise decision.

Investing in growing health services business, product diversification, instituting changes in an effort to become more consumer-centric, and investments in technology have helped these companies reap hidden opportunities. Their business models are now buffered to a large extent to counter the upcoming changes in regulations.

What Are the Factors That Could Drive the Sector?

First and foremost, this is an industry that will continue to witness demand for its offerings given an aging population and no end to new and varied diseases. Strong pipelines, innovative services, better claims handling and increased health care spending should support growth.

Increased investments in technology and use of analytics have better equipped insurers to make informed decisions about premium pricing and claims handling. Adoption of technology has also led to better records handling, which has consequently reduced duplication of services that caused wastage and increased medical spend.

Why Health Insurance Stocks Still Have Some Upside Left

While the industry has outperformed the broader market lately, valuations are far from stretched and leave room for further upside.

The Zacks HMO industry is currently trading at 18.8x forward 12-month consensus EPS estimates, compared with 19.8x for the S&P 500 index as a whole. Over the last five years, the industry has traded in a range of 8.5x to 19.4x, with a median of 12.6x.

Please note that the low valuation point (8.5x multiple) was in 2010 when the ACA was enforced. What this shows is that while HMO stocks aren’t cheap, they’re also not nose-bleed expensive.

Positive Zacks Industry Rank

Within the Zacks Industry classification, health insurers are grouped in the Medical – HMOs.

We rank 250 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. We put our industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by more than twice as much.

The group’s Zacks Industry Rank #14 (top 4% of the 250-plus Zacks industries) indicates further upside. Our back-testing shows that the top 50% of Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

HMOs Worth Adding

In this mixed environment, sidelining the entire industry would not be prudent. Rather, there are chances of scooping up big gains from this corner, which despite short-term hiccups has a bright long-term growth trajectory.

Investors can consider the following HMO stocks that have solid fundamentals to weather any regulatory change. Also, their favorable Zacks Rank makes them solid picks.

Triple-S Management Corp. (GTS - Free Report) beat estimates in the last quarter by 317%. Also, the Zacks Consensus Estimate for 2017 and 2018 moved up 760% and 13%, respectively, in the last 60 days. The stock carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Anthem Inc. (ANTM - Free Report) has a Zacks Rank #2. The stock beat estimates in three of the last four quarters with an average positive surprise of 8.6%. Also, the Zacks Consensus Estimate for 2017 has moved up 0.2% in the last 60 days.

UnitedHealth Group Inc. (UNH - Free Report) carries a Zacks Rank #2. The stock beat estimates in each of the last four quarters with an average positive surprise of 4.6%. Also, the Zacks Consensus Estimate for both 2017 moved up 0.7% in the last 90 days.

Select Medical Holdings Ltd. (SEM - Free Report) carries a Zacks Rank #2. The stock beat estimates in three of the last four quarters. Also, the Zacks Consensus Estimate for 2017 and 2018 moved up 5.7% and 4% in the last 60 days.

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