August 5, 2011 / 5:55 PM / 7 years ago

Analysis: Battered healthcare stocks ready for rebound

NEW YORK (Reuters) - Sharp falls in U.S. healthcare stocks this week — where industry bellwethers dropped as much as 8 percent in one day — were a premature sell-off, analysts say, as the sector’s underlying fundamentals remain strong.

Companies from hospital operator HCA Holdings Inc to drugmaker Pfizer Inc came under pressure before the broader market sell-off on Thursday on concern about possible government cuts to the Medicare health program for the elderly under a new U.S. debt deal.

Analysts say there is potential for some sector stocks to see a rebound of up to 15 percent.

“The reaction by and large is probably overdone,” said Bob Phillips, co-founder of Spectrum Management Group in Indianapolis. “A number of these stocks are still paying great dividends and valuations are incredibly great.”

Healthcare had been the best performing sector during the first half of the year, with healthcare exchange-traded funds and products garnering $859.3 million in net new assets, according to the latest BlackRock ETF industry report.

“Demographically, no matter how you shake it, the population is aging, people will require more healthcare as they age,” Phillips said. “We’re comfortable with the overall sector and think it will do well over the next 10 years, whether the government is the direct payer or not.”

HEALTHCARE PROVIDERS

Healthcare providers face the most pressure, given that Medicare costs — which are expected to nearly double in 10 years — are likely to be first on the chopping block as Washington works to trim down its deficit.

“Cutting benefits to Medicare is cutting benefits to providers,” said ETF Digest Editor Dave Fry.

Insurers UnitedHealth Group Inc and Humana Inc are two stocks that have been heavily battered, both down about 13 percent from the start of last week. They fell below their key 100-day moving averages for the first time this year, which could set up a healthy rebound in the near term.

“That tends to be a pretty strong level of support,” said King Lip, chief investment officer at Baker Avenue Management in San Francisco. “We’ll probably see a few more days of normal trading here, but the stocks could easily rebound 10 to 15 percent.”

Both companies raised their full-year earnings forecasts. UnitedHealth raised its range by 20 cents to a range of $4.15 to $4.25 per share. Humana raised its range by 60 cents to a range of $7.50 to $7.60 per share.

Analysts at Credit Suisse gave Humana an “outperform” rating this week and said the stock’s dip presents a good buying opportunity, noting it is well-positioned to pass cuts through to providers and members.

The analysts said Humana is trading at nine times their 2012 EPS estimate, UnitedHealth is trading around 11 times their EPS estimate.

“We believe HUM is undervalued considering our estimate for 9 percent organic enrollment growth in the core Medicare Advantage product next year,” the analysts wrote in a note.

HEALTHCARE PRODUCT SUPPLIERS

Some healthcare product and pharmaceutical companies, which took a hit with the broader sector, have upside potential.

Lip noted that this year’s healthcare rebound followed a substantial dip in the wake of the U.S. healthcare law, which passed early in 2010, and expects a similar pattern now.

“A lot of these stocks sold off because of overall fear. The fact of the matter is they rebounded after that and started hitting new highs,” he said. “We see similar issues here with people selling the news. But after things calm down and are not as bad, we’ll see institutional buyers come back.”

Drug and device makers Abbott Laboratories and Johnson & Johnson, both down around 6 percent since mid-July, are attractive stocks to Phillips.

Johnson & Johnson is a potential buy now for 13 times its earnings. The stock had been trading in a range of $65 to $67 since late April. This week it fell as low as $61.05.

The stock is also trending below its 100-day moving average for the first time since mid-April this week. The last time Johnson & Johnson opened below its 100-day moving average, it rose about 6.5 percent within two days.

Phillips said Abbott, with a 14.9 price to earnings ratio, is a “compelling valuation.” A price-to-earnings ratio below 15 is considered attractive for the health sector as it translates to about a 7 percent earnings yield, Phillips said.

Abbott shares were down 6 percent since the start of last week, after gaining 10 percent from the start of the year.

HEALTHCARE ETFs

Since each company will be affected differently by any cuts to healthcare spending, ETFs tracking the broader sector may begin to look more attractive to investors hoping to mitigate company-specific risk by diversifying opportunities.

The iShares Dow Jones Health Care Providers Index Fund had been up about 20 percent since the start of 2011, but dropped about 11 percent over the past week.

The ETF is likely to be under the most pressure because it is solely built upon providers. It tracks 52 stocks and has a 14.1 percent weight in UnitedHealth, its biggest holding, and a 4.6 percent weight in Humana.

The SPDR Health Care Select Sector Fund is a more diversified healthcare ETF, consisting of 54 holdings with 48.7 percent in pharmaceuticals, 19.4 percent in healthcare providers and services, 16.5 percent in healthcare equipment and supplies, among its biggest holdings.

The ETF is down about 8 percent since the start of last week, dipping below its 200-day moving average for the first time this year on Tuesday. The ETF had previously been trading in a high range of $34 to $36, about a 12-percent gain from the start of the year.

“These stocks have been unfairly punished on something that might not even occur,” Baker Avenue’s Lip said. “Nothing is written in stone yet. I think we’ll definitely see a rebound in the short term, or at least more of a technical bounce.”

Editing by Andrew Hay

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