Healthcare

The Pro-Cyclical US Healthcare Thesis – Impact of ROW Economic Risks

Written February 5th, 2012 by

US healthcare demand growth is slow for cyclical reasons; this implies an acceleration of US healthcare demand as the broader economy improves; we recommend hospitals (e.g. HCA, UHS, THC), HMOs (e.g. UNH, WLP), and non-Rx consumables (e.g. BAX, BDX, COV) as pro-cyclical bets

Hospitals and HMOs obviously are US-focused; however non-Rx consumables generally are multinationals with exposure to export market risks, forcing the question of whether ex-US (especially EU) economic risks outweigh pro-cyclical upside in the US

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Hospitals’ Stable to Improving Net Pricing Power

Written January 23rd, 2012 by

Hospitals trade at a 30+% discount (’13 PE forward) to cap-weighted Healthcare and the SP500; fundamental concerns appear centered on a combination of weak volume / procedure mix, and the effect of Budget Control Act (BCA) related Medicare rate cuts in 2013

US healthcare demand has slowed for almost entirely cyclical reasons; 2010 was a 50-year low for the cyclical components of demand (per-capita ‘units’ and ‘mix’). Improvements to volume and mix are more likely than either continuation of the 50-year low or further declines; this augurs well for volume-sensitive healthcare sub-sectors generally, and hospitals specifically Read the rest of this entry »

And Now Some Humble π … Brand Drug Pricing Runs the Traditional Election-Year Red Light

Written January 11th, 2012 by

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We had generally expected brand drug pricing to decelerate into 2012, but the January price trend is fairly convincing evidence that we simply got this wrong – real pricing gains for brand drugs are continuing apace

As we’ve shown previously, brand drug pricing tends to decelerate into the primary seasons (i.e. now) of general election years, particularly when prices grew in real terms in the pre-election year (as they plainly did in ’11, Exhibit 1). What’s different this time is the extent to which the brand drug subsector depends on real pricing for revenue growth (Exhibit 2). Not only are pricing actions a whole number multiple of US revenue growth, the companies also are under rising sales pressure as EU conditions weaken. This level of need presumably explains the industry’s continued real price growth into the election season Read the rest of this entry »

US Healthcare Demand Slow for Cyclical (i.e. Temporary) Reasons; Volume-Sensitive Names are Undervalued

Written January 11th, 2012 by

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From 1960 to 2007 average per-capita ‘units’ and ‘mix’ of care (which we follow using an aggregate measure termed ‘elasticity/mix’) grew 2.2% (real, per-capita) annually, then fell 40bp each year from 2008 through 2011, reaching a 50-year low in 2010

Changes in per-capita elasticity/mix are starkly cyclical, and account for the entirety of the post-2007 fall in US healthcare demand. The fall in per-capita ‘units’ of care (e.g. physician visits & acute care admissions) appears to have been more important than any change in the ‘mix’ of care Read the rest of this entry »

US Drug Pricing in 2012 – The Slowing Crowd

Written January 5th, 2012 by

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We expect US brand drug pricing to decelerate in 2012. Whether we’re right or wrong should soon be known; much of the industry’s annual pricing actions fall in January, and we believe the January actions of the early companies influence the tempo of those that follow. Three companies have reported thus far; as yet there’s no clear trend, but we’ll update regularly on this blog as January pricing actions occur

For obvious reasons, the rate of growth in US brand drug prices typically decelerates into presidential election years, particularly when prices grew in real terms the year prior (Exhibit 1). Brand drug pricing has been accelerating in recent years (Exhibit 2); accordingly the typical conditions for an election-year deceleration in real pricing have been met

Despite the consistent historic trend whether, and to what extent, brand drug prices may decelerate in 2012 is an inherently subjective call. To begin with drug pricing is a balance of risk and need – political risks presumably are at least very slightly lower than in other election cycles for the simple reason that the health care ‘channel’ of the broader electoral ‘bandwidth’ is dominated by the binary question of whether the Affordable Care Act (ACA) should be repealed. And, the need for US real pricing gains is substantially higher than in past election cycles both because US revenue growth is far more reliant on real pricing than perhaps ever before (Exhibit 3), and because ever-tightening EU budgets continue to force global sales forecasts lower. Continuing on the subjective theme, we believe that in any recent (past 2 decades) year brand drug pricing behavior follows a crowd dynamic governed by a collective sense that double-digit increases are somehow ‘too high’, and by an individual sense of not wanting to post the highest rate of increase, or even to be among the top three – and in our experience this crowd dynamic – and its slowing effect on pricing — is particularly acute in election years Read the rest of this entry »

Dismal EU Growth Forecasts Mean Pricing Pressure on (Innovative) Healthcare Exporters

Written November 15th, 2011 by

On Thursday, the European Union cut its 2012 real GDP growth forecast to just 0.5% – down nearly 70 percent from its 1.9% projection just six months ago. Ominously, the EU added that “the probability of a more protracted period of stagnation is high. Given the unusually high uncertainty around key policy decisions, a deep and prolonged recession complemented by continued market turmoil cannot be excluded.” We anticipate this implies more export-market pricing pressure, and view this pressure as a dominant systematic risk to healthcare portfolios in the immediate term

In a call late last year we argued that exporters of healthcare products to European countries – where governments tend to be the dominant purchasers – faced intense pricing pressure as a result of the Euro zone debt crisis; and that makers of more innovative products (pharmaceuticals; artificial joints; pacemakers) faced greater risks than makers of less innovative products (gauze; bandages; sutures)

Our working thesis was that the relationship between the rate of change in consumables imports and the rate of change in GDP should be distinct across the three subcategories of hi-tech (more innovative), mid-tech, and lo-tech (less innovative) medical products. More specifically, we expected higher tech consumables to decline more when GDP was contracting – consistent with the idea that these governments’ single-payors would preferentially seek to reduce pricing on higher-margin innovative products during times of economic stress. Lower-tech products should behave more like commodities, wherein demand growth associated with an economic recovery would be more likely to increase commodity manufacturers’ capacity utilization, thus exerting at least a modest upward effect on pricing

When we examined imports of products in these categories into developed markets over several economic cycles, from 1989 through 2008, we found that in fact the change in demand during times of economic stress (GDP contraction) clearly follows the pattern we suggest – hi-tech consumable imports fall far more with a falling GDP than mid-tech consumables, which in turn decline far more with a falling GDP than lo-tech consumables (Exhibit 1). The dynamic is reversed (though far less responsive) during periods of economic growth

Plainly, these findings are daunting for manufacturers selling into the EU, particularly in the context of the updated growth forecasts – near zero; declining; risks heavily skewed to the downside – and immediate threat of further drastic austerity measures throughout the region. At the level of healthcare subsectors large-cap pharmaceuticals and biotech generally are most exposed

Individual Mandate Now 2-1-1 in Circuit Court; Supreme Court Will Weigh-In…

Written November 14th, 2011 by

On November 14 the Supreme Court agreed to review the constitutionality of the Affordable Care Act’s individual mandate, granting petitions for writs of certiorari on four aspects of the 11th Circuit Court’s decision in Florida et al v. Dept. of H&HS et al

Specifically, the Court agreed / asked to hear arguments from all parties regarding the following questions[1]:

(1)    Anti-Injunction Act Applicability (Supreme Court order)

“Whether the suit brought by respondents to challenge the minimum coverage provision of the Patient Protection and Affordable Care Act is barred by the Anti-Injunction Act, 26 U.S.C. §7421(a)”

(2)    Constitutionality (Dept. of H&HS et al petition for writ cert)

“Whether Congress had the power under Article I of the Constitution to enact the minimum coverage provision”

(3)    Severability (National Federation of Small Business et al[2] petition for writ cert; Florida et al petition for writ cert)

“Whether the ACA must be invalidated in its entirety because it is nonseverable from the individual mandate that exceeds Congress’ limited and enumerated powers under the Constitution”

“[Whether] the Affordable Care Act‘s mandate that virtually every individual obtain health insurance exceed[ed] Congress‘s enumerated powers and, if so, to what extent (if any) can the mandate be severed from the remainder of the Act”

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PBM Pricing Post-AWP – An Estimate of Sustainable Earnings Power

Written November 13th, 2011 by

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Using Medco (MHS) as a proxy for large PBMs, we show that generic buying margins dominate PBM gross profits; PBMs appear to have sacrificed most (or even all) alternative sources of gross margin, levering the industry’s pricing structure almost completely to generic spreads

As the Average Wholesale Price (AWP) pricing benchmark is phased out, the arbitrage in generic margins closes, forcing PBMs to a wholly different pricing model, and raising the question of sustainable post-AWP earnings power. We define sustainable pricing – and thus sustainable gross margin – as a level at which clients’ next best alternative is a less efficient choice than the traditional PBM

As generic dispensing margins fall, PBM clients can recreate retail and mail networks using alternative service providers. Benchmarking to closed loop payment processing margins, we estimate that drug-benefit cards can be issued and a retail payment / claims processing network operated for roughly 2.7% of retail drug costs. For prescriptions filled at mail, we believe post-AWP dispensing margins of $11.04 or less are feasible (v. current retail of $14.10). All-in, this virtual / alternative network can operate on 16% less gross margin than MHS

At the very minimum, we see the large PBMs having to adjust current pricing – and thus current gross margin – by this amount, in order to maintain the total economic benefit (roughly rebates net of fees) that PBM clients presently receive

As available brand rebates fade and generics’ share of dispensing grows, the alternative network becomes increasingly efficient relative to the legacy PBM model, implying that gross margin pressures continue to build well after the shift to AWP

Present consensus calls for considerable earnings growth, implying margin expansion, share gains, or some combination of these, where we see both margin contraction and loss of market share. PBM share prices, at market parity on out-year (2013) consensus, belie the market’s general acceptance of reliable earnings growth

We accept that the relative timing of generic-wave gross profit gains and the negative margin effects we describe above is uncertain, and that we face the near-term risk of gross margins expanding before these pressures unfold, particularly if the market overestimates the synergies or price-stabilizing effects of an ESRX/MHS merger. Nevertheless with share prices reflecting considerable growth in earnings power when rather dramatic (≥ 30%) contraction is far more likely, PBMs remain the most compelling short story in healthcare

ACA at the Supreme Court – What You Should Know

Written October 24th, 2011 by

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This note summarizes the events leading up to the Supreme Court’s likely review of the Affordable Care Act (ACA), and attempts to handicap the timing and outcome of the review

We anticipate a verdict in or around June of 2012. Whether the individual mandate to purchase health coverage is upheld is effectively a coin-toss. If the mandate is struck down, the odds of ACA being struck down in its entirety are extremely low. Rather, we believe the Court would either find the mandate completely severable from ACA; or (marginally more likely) would find that commercial insurance market provisions such as guaranteed issue and the requirement to cover pre-existing conditions are at least partially reliant on the mandate, thus striking these provisions from the Act

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ACO Final Rule Lowers the Bar for Forming and Operating an ACO – Not sure it really matters …

Written October 20th, 2011 by

CMS today released the final rule on Accountable Care Organizations (ACOs); the rule can be found here

Our review of the preliminary rule concluded ACOs, as designed, would have little effect on costs. CMS’ changes to the proposed rule are important, and lead us to at least tweak our view of ACOs

Originally, we concluded that because of the costs (in particular the requirement for a common EMR) and risks (in particular the risk of having to pay CMS for costs above the benchmark) involved in starting and operating an ACO, that only hospitals were in a position to realistically form ACOs, since other candidates (e.g. physician groups) to form and lead ACOs simply lacked the requisite systems and capital. The final rule provides for some ACOs on ‘Track 1’ to share in (albeit modest) savings but not downside risks, which eliminates – or at least dramatically mitigates – the capital requirement. And, the final rule no longer establishes EMRs as a condition of participation, which at least potentially lowers the systems (and again, capital) barrier. (However quality metrics, which can heavily affect the rate of shared savings, still argue for a common EMR). Admittedly these changes raise the odds of ACOs forming, and raise the percentage of ACOs that are likely to be formed by entities other than hospitals

That said, hospitals still should be the most motivated to form ACOs, so the effect of these revisions having opened the door to others may be quite small. Because hospitals are the single largest source of costs – and thus the single largest source of savings – in an ACO, it’s far better (from the hospital’s perspective) to be the hammer (the driver of the ACO) than the nail (the target of the ACO). And, because ACOs should tend to affect Medicare admission patterns – and by extension commercial admission patterns as well – hospitals are uniquely motivated to form ACOs in order to affect (or at least defend) higher-margin commercial admissions patterns. So in a way, the revised rule lets more players on the field, but in a manner somewhat analogous to telling your pre-teen he’s now eligible to suit up for the NFL – now being this Sunday

Our other concerns – and in fact our largest concern – remain unaddressed by the revisions. To our minds the fatal flaw in the design of ACOs is that no member wants to reduce costs by reducing her own billing; she only wants to reduce costs by decreasing the billings of others (arguably with little regard to whether the others are ACO members). This is true for the simple reason that total potential shared savings to any individual provider from not rendering a given service appear to be dramatically less than the marginal profit to that same provider of rendering the service. And with the largest source of costs (and thus potential savings – i.e. the hospital) still likely to dominate ACO formation and leadership, we don’t see large savings as a result. More ‘game theoretically’, the ACO concept, as designed and modified, describes a system whose equilibrium state of affairs will be (we believe) to defend Medicare billings and (Medicare and commercial) admissions patterns, i.e. to defend costs and market share. The defensive motives in the ACO game far outweigh any motive to generate savings – thus we believe no useful savings will be generated

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