Investing in healthcare providers makes sense. People are living longer and need more support. The elderly are an increasingly influential demographic group of voters in many countries, and they are demanding that more is spent on their health.
How healthcare is provided can vary significantly. In the US, however, companies are at the forefront of delivery, with government support for the over-65s through a health benefits programme called Medicare, which funnels cash through to the private healthcare sector.
Benefiting from this scheme is Humana (NYSE: HUM), a $62.9bn US health insurer and care provider with more than 17 million customers. Customers buy insurance directly or indirectly (via an employer or the state), and Humana uses its takings to fund treatments, hospital stays and medication from healthcare operators or provides them in-house. Profitability is driven by increasing how much customers pay while remaining competitive and negotiating lower treatment provider costs because of its size.
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How well this has been working can be seen from the stock’s performance. It has risen by 400% over the past decade, versus a 150% gain for the US S&P 500 index. This comes despite flat and even negative returns from most healthcare providers and other sectors in 2023 as investors focused instead on a narrow group of big tech stocks.
This year has seen an uptick in procedures carried out to catch up on a backlog caused by Covid lockdowns. The surge increases the providers’ costs relative to customers’ payments. But it should clear soon and is already being factored into market expectations, making the lacklustre performance this year a long-term buying opportunity. Over the past decade, moreover, Humana’s sales have more than doubled to $92.8bn and reported earnings per share almost trebled to $20.28, an annualised growth rate of just over 10%.
While this long-term growth speaks for itself, an additional attraction for investors in companies like Humana is their perceived “defensive” quality. Not only do they receive a reliable and predictable portion of their revenue from the US government, individual consumers are less likely to cut back on health costs in a downturn than, say, postpone a holiday. Having some of this long-term defensive growth in a portfolio can’t be a bad idea when higher borrowing costs are hurting consumer and business confidence.
Meanwhile, the potential customer base is widely expected to keep expanding. The number of over-60s worldwide will jump nearly 40% from one billion today to 1.4 billion in 2030, according to the World Health Organisation. It will then rise a further 50% to 2.1 billion by 2050. In the US, there are now 59.4 million people eligible for Medicare and, by 2060 there will be 95 million over-65s, according to other research.
With earnings expected to hit $28.26 per share for 2023 as a whole and then $31.60 in 2024, the price/earnings (p/e) ratio stands at 18, falling to 16 next year. This is not demanding for a well-managed business with a strong track record of high single-digit, long-term sales growth.
This area of the health sector is not going to generate bumper returns enjoyed by some of the pharmaceutical businesses with their breakthrough drugs. But nor will it share in the high risk of product failure and heightened volatility in tougher years. Reliable growth with some insulation from the boom and bust of the economic cycle may just be the kind of tonic plenty of investors have been looking for.
Why Humana has a sweet spot in the US health sector
It would take a whole book to explain the labyrinthine options and permutations on offer in the US medical healthcare sector.
The key is that Medicare is open to all over-65s as well as others with disabilities or specific conditions, but there are choices that individuals can make to enhance their health coverage. For this reason, Medicare has come to be referred to as “traditional Medicare” and the flexibility comes with what are known as "Medicare Advantage” plans.
Advantage is the sweet spot for Humana, which is the second-largest provider after its biggest competitor, UnitedHealth Group. As with traditional Medicare, Advantage provides the hospital stay and treatment coverage but bundles them together with additions such as the cost of prescribed drugs and eyesight and dental care.
In short, Humana is a dominant player in one of the fastest-growing health consumer groups – the over-65s – with the scale to offer a broad product range to maximise sales and offset costs.
While almost all revenues come from insurance premiums, it’s worth adding that it is developing its own primary care centres branded as CenterWell. Growing in-house offerings should mean further cost reductions, boosting profit margins. Innovative use of new medical technologies will enhance this trend.
The firm only recently said that 2023 gains in its individual Advantage membership will be a sector-beating 19% versus the year before. And it does not disagree with the market’s expectation of 37% growth in 2023 adjusted earnings per share. Some 25 Wall Street analysts cover the stock. The consensus 12-month price target is $585 and there’s plenty of scope to build on this, as annual results are released in February.
This article was first published in MoneyWeek's magazine and all information was correct at the time of writing. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
Stephen Connolly is the managing director of consultancy Plain Money. He has worked in investment banking and asset management for over 30 years and writes on business and finance topics.
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