Monday, 22 October 2012

4 Health Care Stocks You Should Know About

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Specialized health care is a large and growing industry that Warren Buffett has taken notice of — and you should, too.

Why does Buffett’s Berkshire Hathaway (NYSE:BRK.A) own 10% of DaVita (NYSE:DVA), a mid- to large-cap operator of kidney dialysis centers? It’s a great company in a good business. And it’s not the only one worth owning in the area of specialized health care.

As a big believer in multi-cap investing, I subscribe to the idea that equity portfolios should be more than large-cap stocks; they should include mid-caps, small-caps and even micro-caps. To that end, I’ll look at DaVita and three other different size companies providing specialized health care that all offer investing possibilities.

DaVita’s market cap is currently $10.7 billion, which for me is a large-cap stock because it’s above $10 billion. But some might define it as a mid-cap, albeit a large one. Whatever your definition, it’s the biggest of the four we’ll look at here.

DaVita is the second-largest dialysis-care provider in the U.S. behind Germany’s Fresenius Medical Care (NYSE:FMS). In August, it told investors it expected operating income of at least $1.28 billion in 2012 on approximately $7.5 billion in revenue.

CEO Kent Thiry has been at DaVita for 13 years and has done a masterful job turning it into a dialysis powerhouse. Both it and Fresensius combined account for 70% of the dialysis patient market in the U.S. Increasing new patients by 3.5% a year, the business provides a steady stream of income.
Ultimately, though, its growth prospects are limited given the consolidation in dialysis, so in May DaVita announced it was acquiring HealthCare Partners, a California-based physician group for $4.4 billion, including $3.66 billion in cash and 9.38 million DaVita shares.

HCP gives DaVita the diversification necessary to become a leading provider of health care in this country. HCP provides patients in Southern California, Nevada and Central Florida with soup-to-nuts medical care while saving costs at the same time. It’s a win/win situation.

Analysts were unsure when the deal was first announced May 21, but they seem to have come around with the stock up 33% as of Oct. 18. Trading at an all-time high, DVA might seem expensive, but by almost every valuation metric it’s less so than Fresenius, its larger rival.

With competent, proven management in place, its future is very promising. Like Buffett, other long-term investors should have no trepidations about owning its stock.

Next up is Mednax (NYSE:MD), a leading medical group providing pediatric and anesthesia services. It employs more than 1,875 physicians in 34 states and Puerto Rico. Its market cap of $3.4 billion puts it firmly in the mid-cap realm, and its stock currently trades about 10% below its five-year high of $76.67.
Mednax provides its physicians with long-term employment contracts that have salary and incentives tied to practice profitability. Its doctors are able to focus on patient care, and as a result its turnover is approximately 5% annually — low in any industry.

Revenues, operating income and earnings per share have grown at compound annual growth rates of 14.6%, 12.8% and 12.6%, respectively, over the past five years. It’s steady as she goes.

In recent years the stock has underperformed compared to both the S&P 500 and medical care industry. Year-to-date, MD is down 1.8%, while the S&P 500 is up almost 18%. Given the strong cash flow Mednax generates, buy MD only if you’re a patient investor. If you’re looking for quick gains, however, this one might not be for you.

On Oct. 17, Forbes named Austin-based Hanger (NYSE:HGR) one of its 100 Best Small Companies in America. It’s a 150-year-old company formed by one man’s vision for a better life for himself and others.
James Edward Hanger was the first amputee of the Civil War, and upon returning home in 1861, he went to work designing a wooden prosthetic that would allow him to move around more easily. A U.S. patent was granted in 1891, and the rest is history.

Today, Hanger, with a market cap of $870 million, is the world’s leading provider of orthotic and prosthetic patient care services, providing assistance for 650,000 patients every year. Like all the businesses in this article, it definitely serves a higher purpose. With an aging population and diabetes a major problem for seniors, Hanger is in an ideal position to serve this market.

Its patient care services currently has 29% of the $2.6 billion market, with no other company possessing more than a 2% share. The industry is ripe for consolidation, and Hanger is just the one to do it.

Like Mednax, Hanger’s growth is steady, if not spectacular. I like businesses with big market share in areas that large companies aren’t interested in. The only caveat for those thinking of buying: Its debt-to-equity ratio is 110%. Given its cash flow, I don’t consider that a problem, but it’s important to be aware of.

Last up is US Physical Therapy (NYSE:USPH), a micro-cap provider of outpatient physical and occupational therapy clinics in the U.S. USPH has 419 clinics in 42 states and is the only pure-play provider of physical and occupational therapy.

Although it does make acquisitions, 70% of clinics are start-ups, and they’re profitable within six to 12 months, providing strong cash flow and a solid balance sheet. The rehab market in the U.S. is $10 billion or more, growing 5% annually. With an aging population, USPH’s services will continue to be very much in demand. More important, no company has more than 6% market share. The business is there for the taking.

Partnering with experienced physical therapists and focusing on sports, trauma and surgical-related cases enables USPH to gain volume via referrals. Its average investment in a start-up clinic is $170,000, which it’s able to recover in approximately three years.

Of the four companies discussed here, I’m most excited about USPH simply because of its stock performance. Over the past 15 years, the shares have averaged an annual total return of 14.2%, 939 basis points higher than the S&P 500. I see more of the same over the next 15 years.

As of this writing, Will Ashworth didn’t own any securities mentioned here.

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