Shares in the sector have recovered from recent weakness, and S&P sees signs of further upside
From Standard & Poor's Equity ResearchOver the past 13 weeks, the S&P 1500 Managed Health Care subindustry index has risen from the dead, and now has a relative strength ranking of 4, indicating that its trailing 12-month price performance is in the top 30% of all 136 subindustries in this composite benchmark (which consists of the Standard & Poor's 500-stock index, MidCap 400, and SmallCap 600 Indexes). Year to date through May 4, the S&P Managed Health Care index increased 5.8%, vs. a 6.6% rise for the S&P 1500. In 2006, the S&P Managed Health Care index fell 6.2%, vs. a 13.3% advance for the S&P 1500.
Take a look at the accompanying chart, which shows this subindustry index's rolling 12-month price performance compared with that for the S&P 1500. Any point above 100 indicates sector outperformance vs. the S&P 1500 over the prior year, while points below 100 show sector underperformance. The red line is a rolling nine-month moving average, while the two green bands indicate one standard deviation above and below the index's longer-term mean relative strength.
Phillip Seligman covers the companies in the S&P Managed Health Care index for S&P. There are 11 large, midsize, and small-cap companies in this subindustry index, three of which carry 4 STARS (buy) opinions: CIGNA (CI), UnitedHealth Group (UNH), and WellPoint (WLP).
Positives Outweigh Competition
Seligman's fundamental outlook for the S&P Managed Health Care subindustry is positive. He sees healthy earnings per share growth at least through 2007, driven by a stronger economy and moderating medical cost trends. In addition, there has been a strong influx of Medicare and Medicaid beneficiaries into private health plans. Also, managed health care organizations (MCOs) will resort to acquisitions to fill in gaps in their geographic coverage or service offerings.
Seligman thinks these positives outweigh the intensifying competition that S&P sees. He believes there's investor concern that the change of control of Congress will hurt the group's prospects. However, we see no change in prospects, at least through 2008, as the Democratic Congress' agenda could be blocked by the President's vetoes.
The analyst continues to see the group as likely to deliver at least 15% EPS growth through 2007, fueled mainly by premium price hikes that are outpacing medical cost inflation, good cost controls, an array of attractive products, and expanding fee-based rather than risk-based membership. He sees low- to mid-single-digit commercial enrollment growth by individual MCOs, partly on our view that retention rates have increased among the group.
Driving Down Costs
Elsewhere, Seligman thinks that standalone Medicare drug programs operated by the MCOs will continue to be only modest contributors to earnings growth. But he sees more meaningful contributions from their Medicare Advantage (MA) programs, which provide managed health care to seniors.
Given the aging U.S. population, S&P expects good long-term prospects for MA. Meanwhile, Seligman sees MCOs benefiting from the increasing number of states turning to managed health care to help them control Medicaid costs. S&P expects most MCOs' medical-cost ratios to be flat to up in 2007.
While medical-cost trends continue to moderate, particularly with the penetration of generic drugs, S&P believes that to attract and retain accounts, MCOs have to reduce premium rate hikes. Many also provide high-deductible, consumer-directed products that have been effective in driving down their medical costs. Seligman believes MCOs also seek to lower selling, general, and administrative (SG&A) cost ratios via IT investments, including those that further automate transaction processing, and by consolidating service operations.
So there you have it. The group's longer-term momentum continues to improve, and the group's overall fundamental outlook is positive, indicating that from both a fundamental and momentum perspective, there's further upside potential.
Industry Momentum List Update
Here's this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).
S&P STARS Rank
Harman Intl. (HAR)
Diversified Metals & Mining
Freeport-McMoRan Copper & Gold (FCX)
Fertilizers & Agr. Chem.
Independent Power Producers
Integrated Telecom. Svcs.
Citizens Communications (CZN)
Metal & Glass Containers
Ball Corp. (BLL)
Boston Properties (BXP)
Estee Lauder (EL)
Tires & Rubber
Goodyear Tire & Rubber (GT)