Analysts Share ‘Mixed Bag’ Views on Various Sectors
Panelists (L-R) Smith, Feinstein, Mayo, Rice, Lehrich, and Morgan discuss the ups and downs of 2011 and the outlook for various healthcare sectors in 2012 © 2012 Harry Butler, Nashville.
The Nashville Health Care Council’s annual panel discussion, Wall Street's View on Prospects for the Health Care Industry, attracted nearly 600 to the Nashville Convention Center last month to gain insight into top research analysts’ thoughts on how healthcare industry sectors are expected to fare in 2012.
Frank Morgan, Managing Director, RBC Capital Markets
Adam Feinstein, Managing Director, Barclays Capital
Darren Lehrich, Managing Director, Deutsche Bank Securities
Whit Mayo, Senior Research Analyst, Robert W. Baird & Company
Moderator Wayne Smith, Chairman, President & CEO, Community Health Systems
A.J. Rice, Senior Financial Analyst, Susquehanna Financial Group
Moderator Wayne Smith, chairman, president and chief executive officer of Community Health System, introduced the panel and noted all five of the experts have received top industry accolades for their analytical acumen. As a whole, the panel’s mood could best be described as cautiously optimistic for several key sectors, although the outlook for home health and medical devices remained gloomy. Although guarded, the group seemed somewhat encouraged by the stronger-than-expected finish to 2011 and the likelihood of a calmer legislative scene leading up to the November presidential election.
The analysts offered a 2012 forecast based on their areas of expertise, including an outlook for the hospital, post-acute, ambulatory, homecare, dialysis, drug management and distribution, medical devices and REIT spaces.
A.J. Rice, senior financial analyst, Susquehanna Financial Group, said the general consensus was that the hospital sector underperformed in 2011. The three issues driving that disappointment, according to Rice, were the ongoing effect of the weak economy, a general malaise regarding the climate in D.C. and a resurgence of regulatory oversight activity.
Ironically, however, he said that with one notable exception, most of the numbers coming out for the fourth quarter of 2011 actually are on target with the guidance offered at the beginning of the year.
“All but one company based in Dallas … which will go nameless,” he said to a roar of laughter from the audience and mock horror from moderator Wayne Smith, “All but that one company will pretty much deliver on what their expectations were for the year … so the companies made the numbers, but the perception swung widely throughout the year.”
Coming into 2012, Rice actually likes how the hospital space could stack up against low expectations. “I think if there is any surprise,” he said, “it’s likely to be to the positive.”
Darren Lehrich, managing director, Deutsche Bank Securities, painted a slightly different picture going forward, however. He said a contradiction existed between the fundamental pieces of the hospital sector and the valuation and stock performance of the companies. On a positive note, Lehrich said utilization is starting to stabilize, and the fourth quarter of 2011 brought growth in commercial enrollment for the first time since the recession started. He also said hospitals have done a good job in managing costs very effectively. On the negative side, however, Lehrich said there is still pressure on the payer mix and more Medicaid cuts to cycle through this coming year.
“So for the hospital investors, I think it’s a dichotomy because you’ll have probably a better fundamental performance, but we believe valuations in this sector will be anchored to a much lower place than where they have been historically because I think we’re setting up in 2013 another BBA-like scenario,” he said of post-election efforts to reign in spending. Lehrich added that if you harken back to the Balanced Budget Act of 1997, of the $425 billion in savings, $390 billion was healthcare-related.
Adam Feinstein, managing director, Barclays Capital, noted, “The best thing about 2012 is it’s not 2011.” He said hospitals saw a great deal of volatility in stock prices, in part, he believes, because of the barrage of headlines coming out of D.C. “I’ve been doing this for awhile now, and certainly I think last year was really unprecedented just in terms of the number of things that just came out of left field in Washington,” he said, referencing everything from RAC audits to the Super Committee. “It felt like we were fighting the tide the whole year.”
However, he anticipates 2012 to be much calmer. While politics will be front and center leading up to the presidential election, Feinstein said the expectation is not much new legislation will actually pass. “The comment about BBA is a very good point, but nothing is going to pass this year that’s going to have that sort of major impact so I think we can get more stability in terms of the headlines.”
Frank Morgan, managing director, RBC Capital Markets, said there is a mixed message in the post-acute space. “I think in post acute care, the good news is certainly volume and utilization will continue to be strong,” he said, adding the concern is what will happen on the reimbursement side since these sectors are often largely Medicare reimbursed. He added that he thinks the rehab market probably has the best volume growth of any healthcare services subsector right now. He said the LTACH space must get an extension of the Medicare, Medicaid, and SCHIP Extension Act of 2007 (MMSEA) or get a patient and facility criteria bill passed to afford the subsector some protections. “There is a lot they’ve got to do externally on the legislative front,” he noted. As for hospice, Morgan said there are still good volume trends and adequate reimbursement right now. However, he added, “I do worry about hospice longer term on the reimbursement front.” Morgan said it seems evident that MedPAC and CMS are honing in on hospice, which might not bode well for future payments.
Lehrich said he thought many analysts shared a mutual viewpoint on surgery centers. “I think the bottom line is the space has just too much capacity, and that’s impacted the growth rates of those companies.” He added he expected 2012 to bring between 1-2 percent revenue growth with very little pricing power in the sector.
When it comes to home care, Whit Mayo, senior research analyst, Robert W. Baird & Company, said, “We’ve been negative on the space really since about May or June of last year, and I don’t think there’s much to change our tone right now.”
He added that he expected “flattish” growth on the high-end of the spectrum and projected revenues would be down 5-6 percent on the low end.
“This is the second consecutive year of severe, severe Medicare reimbursement rate cuts.” He added the expectation across the subsector is about a 3.2 percent cut. However, Mayo continued, “Providers that have really focused heavily on riding the therapy train for a long period of time are going to see rate cuts probably in the 5-8 percent range … and that’s on top of a 5.2 (percent cut) last year. So you take a 12-plus percent cumulative rate cut, and there’s just no way you can really grow yourself out of that hole.”
He added the home care sector also tends to feel a lot of regulatory pressure, which he said would probably get worse before improving. Finally, Mayo said the sector needs to demonstrate its value proposition to policy makers. “And in today’s legislative environment, we’re just not too optimistic that’s going to gain a lot of traction this year.”
At the polar opposite end of home care is the dialysis space. Mayo noted, “Dialysis probably has all the characteristics that we’re looking for in terms of fundamentals for the year.” He added that infrastructure includes accelerated volumes, organic growth, plentiful M&A activity, and solid cash flow. Mayo said the sector has “very benign reimbursement risk … probably until CMS decides it’s time to recalibrate the bundled payment system, and that’s probably not until 2014 or so.”
“We think that’s a very good sector in the year ahead,” Morgan said of pharmacy benefit managers, adding there are big external events going on in terms of mergers and acquisitions. He added that PBMs are winners in healthcare reform since more insured lives equals more individuals with a drug benefit. Morgan added there is a “great wave of generics coming. That’s really good for the PBM business.”
Rice called drug distributors a “safe haven” because they don’t rely heavily on government reimbursement and have “virtually no exposure to the economy.” Rice said, “For people that are worried about those macro themes, this would be a nice place to hide out with good dividend yield and ongoing share repurchases.”
He added the wave of generics also benefits this sector. “All the three major names outperformed last year, and we would actually continue to expect them to outperform,” Rice said of Cardinal Health, McKesson and AmerisourceBergen, which control 75 percent of the nation’s drug distribution.
Feinstein said, “Our view there is this has been a very stable sector.” He added that investors are attracted by the stability and high dividends. “We’ve seen those stocks do really well as those companies have benefited from very sound strategy in terms of having high-quality operators.”
As compared to REITS, Feinstein said, “On the med-tech side, it’s a different story. We think there, we’re really in a multi-year down cycle. We think innovation is at a low point, and we think pricing has been way too high in med-tech for several years.”
He predicted lower-than-average growth rates for the sector, as a whole. In some areas, such as orthopaedic and cardiac rhythm management devices, that used to grow 8-10 percent every year, Feinstein said last year actually saw losses of 3-4 percent.
With the big changes coming in the device industry, Feinstein said the possible silver lining is that there should be more M&A activity in the future.