Prescription for an Ailing Market

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The New York Sun

The stock market’s latest roller-coaster ride, a wicked 224-point loss in the Dow Jones Industrial Average on Thursday followed by a rousing 302-point gain on Friday, is a loud-and-clear signal that if you want to preserve your assets, this is the time for defense and safety, not offense and risk.

So what’s a sound prescription for beleaguered stock players anxious to protect their wealth, minimize their losses, and possibly even make a buck in the process?

According to Morgan Stanley, you should take your portfolio to the hospital, as it may require some surgery. That is, be a player in hospital stocks, which it views as strong medicine for ailing portfolios.

As of now, that medicine appears to be working, with hospital stocks posting about a 5% gain versus a double-digit decline in most major indexes.

A Morgan Stanley analyst, David Veal, sees continued healthy results for the sector, his confidence largely rooted in the brokerage’s recent survey of 66 hospital CEOs and CFOs, which found that admissions and pricing gains for acute care facilities are exceeding expectations even in the face of a weakening economy. Indeed, the analyst points out, 50% of the hospitals have seen volume gains this year of 1% or more.

Significantly, the gains realized during the first quarter, Mr. Veal notes, are attributable to more than just a strong flu season; most notably, they are due to stability in the underlying business. Further, he points out, many of the survey’s respondents continue to report that managed care pricing gains are accelerating by 200 basis points or more, and that bad debt levels remain relatively stable.

His analysis of hospitals, based on a number of metrics, leads Mr. Veal to favor rural facilities against their urban rivals because of stronger economic fundamentals in those markets, driven by the rebirth of manufacturing and the commodities boom.

Mr. Veal sees an expansion for price-to-earnings multiples across the hospital group. Hospital stocks currently trade at an average 7.1 times his Ebitda estimates (earnings before interest, taxes, depreciation, and amortization), which represents trough multiples for the last five years. Driving the prospects for multiple expansion from currently depressed levels, he says, are consistent volume growth, accelerating managed care pricing gains, and improved sentiment toward the group as the November elections bring health care into focus.

In pitching hospital shares — health care is generally viewed as an effective defensive play in tough economic periods — Mr. Veal says it’s simply the right group at the right time. For example, in the past 15 years, he points out, hospital stocks have tended to underperform the S&P 500 in bull markets, fare about the same in sideways markets, and outperform, as they’re doing now, in bear markets.

LifePoint Hospitals, which generated sales last year of $2.6 billion and is a spin-off of HCA, one of the nation’s largest hospital providers, is Mr. Veal’s top pick. His reasoning:

oOutsize exposure to rural markets relative to its more urban-focused peers.

oIts status as the sole community provider in more than 90% of its markets where above-average pricing gains are more likely.

oOpportunities for a late 2008 turnaround as the company’s strategic initiatives gain traction amid easy year-over-year comparisons.

Yet another plus for the hospital operator is said to be its strong financial flexibility, which allows for greater opportunities for growth through strategic acquisitions, as compared to its peers, many of which are highly leveraged.

The consensus on the Street, according to Thomson Financial, is for Lifepoint Hospitals to earn $2.46 a share this year and $2.59 a share in 2009. Last year’s net was $2.20 a share.

Other hospital stocks favored by Mr. Veal are Community Health Systems, Health Management Associates, and Tenet Healthcare.

On the other hand, he takes a dim view of another hospital biggie, Universal Health Services, because of its high concentration of facilities in such economically weak areas as Nevada, Florida, and California.

A cautionary note: While health care has been a defensive sector in tough economic times, Mr. Veal’s analysis of the industry suggests it’s likely to fare much worse in the next recession.

The New York Sun

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