The Healthcare Stocks You Need to Watch
Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
On Nov. 5, healthcare giant Humana (NYSE: HUM) agreed to buy Metropolitan Health Networks (NYSE: MDF) for $498 million, or $11.25 per share, in cash. Metropolitan is a leading owner of physician practices, operating through its MetCare of Florida, Continucare, and Symphony Health Partners subsidiaries. The company provides primary care services to 87,500 customers who are enrolled in government insurance (Medicare, Medicare Advantage, and Medicaid) or commercial insurance programs. The purchase price values Metropolitan at 1.1 times FY 2011 sales and 21.9 times FY 2011 net income. As stated in the acquisition press release, Humana hopes to expand the business nationwide, as they seek to vertically integrate and gain greater control over their members’ medical costs.
During the fiscal year ended December 2011, Metropolitan reported revenue of $459.8 million and operating income of $55.1 million, increases of 24.9% and 33.5%, respectively. The company’s growth was primarily the result of its October 2011 purchase of Continucare, which added 19 centers and doubled its customer base to 71,700 as of Dec. 31, 2011. Metropolitan’s cost of providing care, known as its medical expense ratio, improved to 79.0% in FY 2011, compared to 82.1% in FY 2010. During the year, the company benefited from efficiencies in their operations, as well as higher payments from government insurance programs based on their mix of patients.
Metropolitan hoped to deliver economies of scale with their Continucare acquisition, and they have continued to deliver for shareholders in FY 2012. For the quarter ended Sept. 30, 2012, the company generated revenues and operating income of $191.1 million and $21.5 million, increases of 106.3% and 82.8%, respectively. While operating margins slipped during the quarter, gross margins improved as the company did an efficient job of managing their customers’ care. Given the current constraints on the health care payment system, the company recognized the need to attain greater size in an expeditious manner and find a strong partner.
Humana is purchasing Metropolitan to gain greater control over medical costs, while also diversifying into faster growing markets. These two companies know each other well, as Humana purchased an HMO from Metropolitan in 2008 and the majority of Metropolitan’s customers are policyholders within Humana’s network. Metropolitan grew its revenues 65.6% over the past four years by adding individual practices and acquiring Continucare. The company has benefited from a rising pool of Medicare participants and a focus on government insurance programs, specifically the popular Medicare Advantage program. As of Sept. 30, 82% of the company’s customers were covered by this plan, which includes care coordination, wellness, and prescription drug benefits.
However, the March 2010 health care law passed by Congress, known as the Affordable Care Act, included various changes to the Medicare Advantage plan that limited payment rates and made the plan less attractive for providers. As a result, efficiencies of scale are of paramount importance and management at both companies recognized the benefits of combining Metropolitan’s business model with Humana’s financial strength and national footprint.
The Next Metropolitan
Now that Metropolitan is off the market, how should investors gain exposure to the sector? One option would be to spend four years in medical school, enter a residency program, and then start a primary care practice. That is probably not the best option. A better choice would be to find well-run healthcare services companies that are focused on the same population that Metropolitan served. The Affordable Care Act passed by Congress in 2010 expanded government insurance programs, especially Medicaid, and two companies focused on this subgroup are Centene (NYSE: CNC) and Molina Healthcare (NYSE: MOH).
It has been a volatile year for both companies, as management deals with continuous changes to the government insurance programs. For the third quarter ended Sept. 30, 2012, Centene’s revenues jumped 88.0% to $2.4 billion, while it reported an operating loss of $27.6 million. The company benefited from a 55.0% increase in total membership, but operating results were heavily impacted by losses in its Kentucky subsidiary. Meanwhile, Molina Healthcare reported similar trends in the third quarter of 2012, with revenues rising 30.9% to $1.5 billion and operating income declining 78.6% to $7.2 million. In 2012, the company has faced similar pressure in its underlying business, with profitability declining sharply as medical costs outstrip revenue gains from rising membership levels. However, both companies expect a rebound in their financial results in FY 2013, as cost containment programs work in tandem with potential premium rate increases in select markets.
The landscape for the healthcare services industry will be constantly changing, as the Affordable Care Act is implemented over the next few years. Undeniably, the law has provided millions of customers for companies that can manage the growth and price their services prudently. While the sector is a work in progress until costs can be accurately forecasted, investors should watch for a good entry point into this growth industry.
rghanley owns shares of Metropolitan Health Networks. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.