ACA, Hospitals and Investors Face Uncertain 2017

December 21, 2016

Among the many implications of November’s presidential election, there are few more impactful than those for the healthcare sector. With talk of repealing the Affordable Care Act (ACA) growing louder by the day, the landscape for all parties in the industry remains full of uncertainties that render investing a difficult prospect as 2017 approaches.

While investors and pundits are quick to draw conclusions, Mizuho analysts have repeatedly advocated for caution with regard to investing in the sector until more concrete details are disclosed. 

Considering a historical look at the industry, potential outcomes for the ACA and a few industry bright spots, Mizuho analysts provide a comprehensive picture of the healthcare landscape as we approach the realities of a Trump presidency. 

Not a New Phenomenon 

The incoming administration has created uncertainty that makes investing in the industry a particularly daunting task, notes Mizuho Director of Research Sheryl Skolnick, particularly when considering the dramatic effect that government influence has had on the industry over time. 

“Washington has been infamous for dealing the sector ‘exogenous whacks’ that create tidal waves of change in the industry from time to time,” Skolnick says. Among previous examples is the 1997 BBA mandate, whose resulting management decisions led to the bankruptcy of most of the publicly traded sub-acute/SNF companies.

At the time, Skolnick says, she was issuing warnings that went against the tide. In this instance, her diagnosis is equally definitive and even more austere.

Mizuho Sounds Clear Warning

“When the right answer to the question, ‘What will happen to the ACA, Medicaid and Medicare?' is we don't and can't know, we see it as dangerous ground for investing,” Skolnick wrote in a note and has reiterated to the media.

“Any investing going on right now is on the basis of guesses, and some of those guesses are more educated than others. But nobody really knows,” she said to MarketWatch in November. 

While the potential repeal of the ACA will clearly take time, the future of the industry appears to hang in the balance. And with the issuance of a November 21 note partly entitled “Why You Should NOT Buy Hospitals,” the message of caution comes through loud and clear.

“Maybe I’m being overly pessimistic and negative” in contradicting general assumptions about managed care growth, Skolnick said. “It’s very clear that the law is the law for now... What’s at risk is [2018] and beyond.”

The Path Forward for ACA

Predictably, there are major implications for the sector, dependent on continued political momentum against the ACA. In her research, Skolnick identified a few potential outcomes while reiterating that uncertainty prevails. 

“I think it would be imprudent to assume anything will go as expected by the normal Republican playbook,” Skolnick said to MarketWatch. “Investors are paid to assess the probability of an outcome... at this point in time, it’s an extraordinarily risky strategy.”

While some of the gaps in information have been filled, such as the appointment of Tom Price to head the Department of Health and Human Services, there are a variety of potential outcomes for Obama’s extensive healthcare bill.

The first test of whether or not Republicans have the guts to repeal and/or replace the ACA will come on the first day of the new session of Congress in January, which is when incoming leadership can change the Senate rules to invoke cloture with 60 votes. 

According to Mizuho, a full repeal would result in a 1% - 6% loss of EBITDA for the companies in their research coverage universe at best. On the other hand, the worst-case scenario would be if the expansion evaporates and the Medicare rate cuts stay in place, potentially offset by reductions in DSH cuts.

In other words, “for companies that are already experiencing fundamental pressures from underperforming assets, the repeal of the ACA just deepens an already impressive hole. They’d have to dig harder and longer to get out,” according to Skolnick.

Enough with the Darkness, Where is the Light?

While the outlook for hospitals and managed-care may be dim, there are subsectors of the industry where opportunities remain.

Mizuho analyst Ann Hynes has made a few adjustments since the election that are indicative of larger industry trends. While Skolnick downgraded all her ACA vulnerable buy-rated stocks to neutral immediately after the election, and recently raised UnitedHealth (UNH) to buy, Hynes upgraded McKesson Corp (MCK) and Amerisource Bergen (ABC). She noted that “rhetoric on drug pricing will diminish significantly, leading to more stable earnings (and potential upside) if/when changes in manufacturer drug pricing becomes more stable.”

The pharmaceutical industry has responded similarly with positive momentum following the election results based on expectations of diminished scrutiny regarding drug pricing going forward. 

In addition, an investor survey taken at the Mizuho Investor Conference in New York on November 14 has revealed optimistic expectations for the biotech and pharmaceutical sectors in 2017. 

85% of investors voiced the opinion that biotech / pharma will outperform the S&P in 2017, showing less certainty for outperformance of specialty pharma (58%) and doubts for healthcare services (38%). The overall favored subsector proved overwhelmingly to be biotech with 73% of the vote.

Only time will tell what is to come for the sector, but if history is any indication, investors would do well to heed the advice of Mizuho’s healthcare research team and approach with caution. 

Simon Hylson-Smith

CEO, Paragon

Simon Hylson-Smith is a former financial industry editor and currently CEO of Paragon.

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