First-quarter earnings (reported so far) have showed all-around strength backed by a strong economy. Even the Fed, in a recent comment, stated that “economic activity has been rising at a moderate rate.” Business investment “continued to grow strongly,” reinstating the firm footing that the U.S. economy is on.
Importantly, the U.S. economy featured a record-low unemployment rate and gradual wage increase, both of which bode well for the healthcare sector. High employment increases demand for healthcare, and in turn the size of the healthcare market. This in turn pushes up the number of participants with the entry of new hospitals or expansion of existing hospitals, expansion of products and services by insurers, higher demand for diagnostic and lab service operators, and more.
Moreover, an increase in wages would raise consumers’ propensity to spend on costly healthcare services (it is to be noted that U.S. healthcare is the costliest in the world). While insurance covers a large part of healthcare spending, the rise of high-deductibles health plans in recent years had kept consumers away from the market when the unemployment rate was high and wage growth was low. High deductible requires the insured to pay the initial amount (which is quite high), before the insurance coverage kicks in.
The overall bullishness reinforces our sentiment that the growth cadence for the sector should continue. Let’s take a look at the factors affecting Q1 results for payers in this sector.
Acute Flu Season
The 2017-2018 flu season was severe and has been a shot in the arm for the hospital operators, diagnostic and lab service providers, and companies in the drug supply chain. Most of the hospital companies that reported first-quarter results saw an increase in emergency rooms and inpatient admissions on account of flu.
According to an article in Pharmacy Times, this flu season broke records in terms of higher-than-average hospitalization rates. According to the report, the overall and all age-specific hospitalization rates surpassed the end-of-season hospitalization rates for the 2014-2015 season, which was also an influenza-A predominant season categorized as high severity.
Nevertheless, increased flu activity has been a pain for insurers, having been slapped with high claim costs as more patients seek treatments and file for claim on their health insurance cover.
Aging Population to Fuel Demand
The aging U.S. population has been one of the main drivers for healthcare services, as retirees demand more healthcare services in their old age. The graying population of America has led to an unprecedented rise in demand for Medicare Advantage (MA) plans, a private version of the Medicare plan provided by the government to the retirees.
While previously Medicare was provided by the government to Americans, saddled with high cost in recent years, the government is increasingly outsourcing this program to the private health insurance, which has effectively managed costs for this program. This has led to an increase in private participation in the MA market. These plans have been highly profitable for health insurers.
Since MA members have higher medical utilization rates, they bring in about three times more revenues than commercial members, which has helped top-line growth of the companies engaged in MA. Also, health insurers have been able to maintain profitability in these plans by keeping claim cost down via measures such as preventive healthcare and accountable care organizations.
This business has proven to be a cash cow for the health insurance industry. Health insurers UnitedHealth Group Inc. (UNH - Free Report) , Humana Inc., Centene Corp. that have already reported earnings results this quarter have reported an increase in membership in MA, which has aided revenue growth.
We, however, expect to see high capital costs for hospitals as companies invest in the electronic health record system. Moreover, high labor expenses in its largely unionized workforce would cause a rise in labor and wage expenses, which should weigh on their margins. For health insurers, a number of acquisitions made recently should lead to an increase in acquisition integration costs. Adoption of technology would entail greater expenditure too, thereby raising operating costs.
As a result of the Tax Cuts and Jobs Act of 2017 which became effective in December 2017, companies in the health care space project a reduction in the corporate income tax (CIT) rate. Most of the companies that have reported first-quarter results so far have seen higher margins on account of lower taxes.
The tax reform, however, repealed Obamacare's key requirement that all Americans obtain health insurance, which would cause an increase in uninsured rate. But since this provision will be effective in 2019, we would not feel an impact in the first quarter earnings.
3 Healthcare Stocks to Buy Heading in to Q1
The aforesaid factors will surely help healthcare companies to emerge as winners in Q1. The healthcare industry is a part of the broader Medical sector.
For the Medical sector, we now have Q1 results from 83.1% of the sector’s total market cap in the S&P 500 index. Total earnings for these companies are up 14.7% on 8.1% higher revenues, with 88.9% beating EPS and 75% beating revenue estimates.
Let’s take a look at some of the stocks that are poised to beat estimates in the first quarter. These stocks have a Zacks Rank of 1 (Strong Buy), 2 (Buy) or 3 (Hold) and a positive Earnings ESP.
Envision Healthcare Corp. operates as a financial holding company for TBK Bank, SSB that provides banking and commercial finance products and services to retail customers and small-to-mid-sized businesses in the United States. The company is expected to report earnings results for the quarter ending March 2018 on May 7.
Envision Healthcare has an Earnings ESP of +0.52% and a Zacks Rank #3. The company surpassed earnings estimates in two of the last four quarters, with an average positive surprise of 1.15%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Addus HomeCare Corp. (ADUS - Free Report) is a comprehensive provider of a broad range of social and medical services in the home. The company's services include personal care and assistance with activities of daily living, skilled nursing and rehabilitative therapies, and adult day care.
The company is expected to report earnings results for the first quarter on May 7. Addus HomeCare has an Earnings ESP of +11.39% and a Zacks Rank #3. The company surpassed earnings estimates in two of the last four quarters, with an average positive surprise of 1.81%.
Adverum Biotechnologies, Inc. (ADVM - Free Report) is a gene therapy company. The company discovers and develops novel medicines for patients living with rare diseases.
The company is expected to report earnings results for the first quarter on May 8. Adverum Biotechnologies has an Earnings ESP of +6.9% and a Zacks Rank #3. The company surpassed earnings in two of the last four quarters.
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