Health Stocks Should Prosper Under Reforms

While prices and profits face pressures, adding millions to insurance rolls will be a bigger boost.

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Big pharma, big insurers, big hospital chains, big pharmacy benefit managers, and big lab testing companies are projected to benefit from the recently passed health reform law. Did you catch the common word there? Big. Even if the legislation's efforts to reduce healthcare spending trim profits in some sectors, analysts say there will be just an enormous upside as 32 million consumers gain health insurance beginning in 2014.

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Jeffrey Loo, an analyst with Standard & Poor's, says that stock traders had largely priced in at least the short-run impact of the reform measure even before it was enacted. Health insurers and pharmaceuticals are the two sectors most affected by the law, and S&P is neutral to slightly positive on both sectors.

The lifting of lifetime caps on benefits and the end of insurance denials for pre-existing conditions will add to health insurer expenses. "But a lot of that will be partially negated by the fact that there are 32 million new customers for the managed care sector," Loo says.

Pharmaceuticals dodged some proposed measures that would have hurt the industry. A plan to allow the federal government to bargain for lower drug prices for Medicare was not in the enacted bill. Neither was a measure permitting consumers to shop for cheaper drugs outside the U.S. And a proposal to trim the period of sales exclusivity for biological drugs was not approved either.

There will be discounts for drugs for Medicaid and Medicare beneficiaries, and over time insurers will close the payment gap for Medicare drugs known as the donut hole. But even while these may be reducing industry profits, he noted, the industry is likely to benefit because people will be more likely to continue taking -- and paying for -- their medications. Today, people often stop or ration their prescription drugs when coverage runs out. Beyond branded drugs, generic drug companies are also likely to thrive in a cost-cutting environment. All drug companies will benefit from those 32 million new health-insurance customers.

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Other healthcare sectors will be helped by those new customers as well, including pharmacy benefit managers and medical testing labs. While hospitals and other care facilities may face some short-term lumps from tightened benefit and performance rules, they will also benefit. Acute care hospitals in particular should see their expenses for uncompensated care reduced over time, as fewer uninsured people seek emergency room care.

S&P's currently has only seven "strong buys" within the major healthcare sectors:

Dr. Reddy's Laboratories (its stock ticker symbol is RDY), Pharmaceuticals.
Express Scripts (ESRX), Services.
McKesson Corp. (MCK), Distributors.
Medco Health Solutions (MHS), Services.
Medtronic Inc. (MDT), Equipment.
Mylan (MYL), Pharmaceuticals.
Teva Pharmaceutical Industries (TEVA), Pharmaceuticals.

Mutual funds with concentrated holdings in U.S. health stocks have performed poorly in the past month compared with other funds, according to Morningstar. It tracks more than 140 health funds and reports they have risen by slightly more than 1.3 percent during the past month. They're up 7 percent for the year so far, which is 14th out of Morningstar's 21 domestic fund categories.

Morningstar recently highlighted four top-performing mutual funds that had at least 20 percent of their stock holdings in healthcare. Analyst David Kathman singled out Fairholme (FAIRX), Vanguard Primecap (VPMCX), Dodge & Cox Stock (DODGX), and Jensen Fund (JENSX). In an early February report, health analyst Christopher Johnson's three favorite health funds were Hartford Global Health A (HGHAX), T. Rowe Price Health Sciences (PRHSX), and Vanguard Health Care (VGHCX).

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