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No Bargains for No-Moat Health Service Providers

No-moat health service providers are most challenged by industry uncertainty.

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Recent Medicare payment reductions and further potential Medicare cuts associated with the debt ceiling legislation have reignited fears over reimbursement pressure in the health-care industry, and as a result, health service providers have faced some of the most severe stock price declines among the sector.  Tenet Healthcare (THC) and  Select Medical (SEM) have witnessed nearly a 20% stock price reduction since July, while  HCA Holdings (HCA),  Kindred Healthcare (KND), and  Skilled Healthcare (SKH) saw over 45% declines during the same period. We have long viewed reimbursement pressure as particularly troublesome for the no-moat health-services industry, which supports our belief that these businesses face slim chances of creating economic profits. Although not completely immune to industry trends, we think undervalued wide and narrow moat health-care companies like  Pfizer (PFE),  Abbott (ABT),  Novartis (NVS),  Medtronic (MDT),  Covidien (COV), and  WellPoint (WLP) can navigate health-care industry headwinds with less difficulty and provide greater investor opportunity.

Reliance on Government Payments Quashes Economic Moats for Health Service Providers
We think health service providers, including hospitals, skilled nursing facilities, and home health agencies, have not been able to carve out moats. High levels of market share fragmentation in these industries keep these operators relatively powerless against consolidated bases of payers and suppliers. As seen in Figure 1 below, a large portion of health service provider revenue stems from government payments through Medicare and Medicaid. Higher-margin private insurance payments result primarily from the large managed care organizations, such as United Health and WellPoint. For health service providers, facing a large consolidated base of payers makes negotiating favorable reimbursements difficult. Acute hospital operators HCA and Tenet focus on building market share in key urban markets, primarily in Florida and Texas, creating greater negotiating leverage with payers in these fast-growing Sun Belt states, which typically see less government oversight of insurance premium hikes. Additionally, the size of these larger operators increases economies of scale and purchasing power. However, non-profit operators, which receive tax advantages in addition to dedicated donors, comprise a large portion of this industry. While HCA, Tenet, and other larger private operators may gain certain competitive advantages, they still face a tough road ahead from all payers, especially from Medicare and Medicaid.

Michael Waterhouse does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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