While Health Care's Bounce May Not Last, Sub-Sectors Can Benefit

Nov. 22, 2004 — Although President George W. Bush’s reelection provided a nice jolt to U.S. health care stocks, it may only be a short-lived bounce since the sector is facing a multitude of problems, some experts in the field caution.

These include the drying-up pipeline of new drugs from the major pharmaceutical companies, a flurry of patents due to expire, and the specter of the U.S. government allowing the reimportation of cheaper generic drugs from Canada and elsewhere, among other woes.

Year-to-date through October, Standard & Poor’s Health Care Sector Index declined 5.3%, while the S&P 500 Composite Index edged up 1.6%. In calendar 2003, the health-care sector rose 16.0%, underperforming the index, which climbed 26.4%.

However, the health care industry is diverse enough to make it difficult to apply blanket assessments. In 2004, for example, managed health care (HMOs), health care supply, and medical device stocks have delivered robust gains, while health care distributors, health care facilities and pharmaceuticals have lagged.

One of the brightest spots in health care have been medical device/technology, which have performed particularly well. “Wall Street views this sub-sector as having no reimbursement headwinds now,” said Arnold Douville, portfolio manager of the American Century Life Sciences/Inv (ALSIX). Indeed, leading companies like Medtronic (MDT) and St. Jude Medical (STJ) enjoy strong pricing power and high demand for implantable cardio-rhythm devices.

“Medical technology stocks still offer opportunities for significant growth, especially for investors seeking accelerating earnings and revenue growth,” Douville said.

Standard & Poor’s believes that medical device stocks should outpace the market in 2004 and 2005, aided by new product launches in cardiology, orthopedics and diagnostics, said Robert Gold, Standard & Poor’s Group Head for the health-care sector. “In our view, there is a good possibility that merger and acquisition activity will accelerate, providing some valuation expansion throughout the device group.”

Within the medical-devices sector, Gold said, Standard & Poor’s has a 5-Star ranking (strong buy) on Hologic (HOLX); and 4-Star rankings (buy) on Kinetic Concepts (KCI), Edwards Lifesciences (EW), Cytyc (CYTC), Given Imaging (GIVN), Boston Scientific (BSX), Inamed (IMDC) and Stryker (SYK).

Another strong performing sub-sector in the industry has been health maintenance organizations. “HMOs have performed very well this year, despite the occurrence of two key negative events,” noted Douville. “One is the long-delayed merger between Anthem Inc. (ATH) and Wellpoint Health Networks Inc. (WLP) [which the California Insurance Commissioner just approved]; and the other was the investigation by New York Attorney General Eliot Spitzer of east coast medical insurers.”

Douville thinks it’s now widely believed that HMOs aren’t the real culprits in the insurance scandal, which has allayed investors’ fears. Otherwise, he noted that managed care stocks have been strong. “The premium rates negotiated by HMOs came in line with Wall Street’s estimates,” he said. “Plus, the victory by Bush and the Republicans is seen as a big positive for managed care companies.”

“Also, HMOs could be clear winners under the Bush administration, although the stocks here are getting a bit expensive,” Douville added. Gold notes that Standard & Poor’s has a neutral outlook on the HMO group, reflecting its belief that operating margin expansion will begin to abate in 2005.