Health Care's Miracle Cure - insurance industry stocks flying high

Kiplinger's Personal Finance Magazine, June, 2001 by Mark McLaughlin

Community targets hospitals in growing towns of less than 100,000 that are sole providers in their markets and at least 25 miles from their nearest competitor. Credit Suisse First Boston analyst John Hindelong points out that rural facilities benefit from lower costs and from a smaller proportion of patients in managed-care programs (which tend to offer lower reimbursements than traditional health insurance).

Nonprofit hospitals, Community's preferred targets, are particularly attractive now. Nonprofits, which account for more than half of the nation's 5,890 hospitals, have been slow to recover from medicare cutbacks and lack the capital to recruit doctors and expand services. As a result, many have been losing market share and are turning to for-profit hospitals for assistance. "It's been a great environment for acquisition," says analyst Taylor. "Everyone is buying assets cheaper now than a few years ago."

At $28, Community sells at 64 times estimated 2001 earnings of 44 cents per share. Michael Yellen, co-manager of AIM Global Health Care fund, says the rich price-earnings ratio is justifiable because of the near-monopoly power over pricing that Community enjoys as a rural operator.

Making smart acquisitions

IF COMMUNITY'S high price-earnings ratio bothers you, check out Universal Health Services, the nation's third-largest for-profit hospital operator. In addition to owning 24 traditional hospitals and 23 out-patient-surgery centers and radiation centers, Universal (UHS; 610-768-3300) operates 37 psychiatric centers. Traditionally, says Taylor, investors haven't been willing to pay as much for behavioral-health centers because of their reputation as poor profit generators.

Universal is thriving on what Yellen calls "a reputation for acquiring assets very cheaply and turning them around." As an example, the company closed deals in January in which it paid $36 million for two psychiatric facilities and one traditional one that generate a combined $65 million in revenues and $6 million in gross operating earnings before interest, taxes, depreciation and amortization. Essentially, Universal paid about one-fourth of what some of its existing facilities are worth.

Such smart acquisitions make Universal more likely than any other hospital company to top analysts' earnings expectations in the near future, says Taylor. At a recent price of $88, Universal sells at 24 times consensus estimated profits in 2001 of $3.78 per share. Analysts expect annual earnings growth of 20% over the next three to five years.

Control over costs

ONE WAY FOR insurers and hospitals to boost profits is to hold down spending on medical procedures. That creates an opportunity for American Healthways (AMHC; 800-327-3822), the leading provider of management services for cardiac disease and diabetes, two of the nation's fastest-growing maladies.

American Healthways identifies health-plan members with chronic diseases and administers programs to keep their conditions in check. "The diabetes program has improved the health status of our members, and has produced medical-cost savings," says Dr. Victor Villagra, a vice-president at Cigna HealthCare, which last year added American Healthways' cardiac services to its existing diabetes program. American Healthways also offers respiratory-disease programs, and this year plans to roll out an overall health-management program covering a wide array of controllable medical conditions.