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4 ‘Buy’-Rated Health-Care Stocks Primed for SCOTUS

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If you’re looking to take long positions in health-care stocks based on the U.S. Supreme Court’s Obamacare ruling, you might as well select quality names.

The Supreme Court is expected to hand down its decision on a challenge to the Patient Protection and Affordable Care Act on Thursday morning. The Act was signed by President Obama in March 2010, and includes an expansion of Medicaid and a mandate requiring individuals not covered by employer-provided or government-sponsored health insurance plans to maintain “minimum essential coverage” or face an IRS penalty, beginning in 2014.

For starters, the penalty for not meeting the individual health insurance coverage mandate requirement has no teeth. The penalty in 2014 will be $95, followed by a $350 in 2017, reaching $750 in 2015, subject to certain adjustments.

Gavin Magor, a senior analyst with Weiss Ratings, said “assuming that the individual mandate is declared unconstitutional and everything else is upheld, which is probably the most likely scenario, the insurance companies and the policyholders will actually be the losers, because of the cost issue.”

According to Magor, insurers’ efforts to prepare for 2014 were “geared around the assumption that there would be a guaranteed growth of policy holders. They can’t just hire in January 2014.” If the individual mandate is thrown out, “the insurers will then have to look at how surviving mandated reforms can be paid for, in the long run, with a smaller policyholder base, so they will be looking at increased rates and they might have to look at more consolidation, and that's very likely.”

“This is a business where the margins are small, and you need to have the benefits of size to actually make money,” according to Magor, who adds that “if the individual mandate is thrown out, health-insurance stocks could drop sharply, but when investors realize that the larger players will eventually be the only ones left standing, we could see a sharp rebound in stock prices for the larger players.”

If you are already holding quality health-care stocks, you probably already believe in the names, and may have a chance to build positions at lower prices before or after the ruling. If you are considering taking a long position, you might have a similar opportunity.

If the Supreme Court decides to uphold the entire Patient Protection and Affordable Care Act, Thursday could provide an excellent selling opportunity.

Citigroup analyst Carl MacDonald said back in March that “commercial managed care names have a lot more upside than downside on the Supreme Court individual mandate decision,” and that “in all but one scenario, the stocks are going higher, and there’s potential for significant upside if the entire reform legislation is struck.” The analyst went on to say that “the perceived negative outcome occurs if the court strikes the mandate but upholds the rest of the bill, but fundamentally, this isn’t so bad, since the penalty for not buying insurance is too weak to really matter.”

MacDonald said last Thursday that following the Supreme Court’s decision, the market will turn “its focus to the November elections, since a Republican victory could have an even more profound impact on the future of health reform than the court.”

While playing stocks based on news headlines is generally a recipe for pain, if you are going to take this approach, you might as well consider high quality names.

TheStreet Ratings takes a very conservative approach to rating all stocks publicly traded on the New York Stock Exchange, AMEX, and NASDAQ, that have at least five quarters of financial data available. The ratings emphasize long-term total returns, as well as revenue trends, capital strength, and dividends, while also considering short-term performance, financial stability and volatility. A rating of B-minus (good) or higher is considered a “buy” recommendation.

Here are the four U.S.-based health-insurance or benefits management companies with the largest market capitalizations with “buy” ratings from TheStreet Ratings:

UnitedHealth Group

Shares of UnitedHealth Group of Minnetonka, Minn., closed at $58.80 Tuesday, returning 17 percent year-to-date. The stock is rated “A+” (excellent) by TheStreet Ratings.

Based on a quarterly payout of 21.3 cents, the shares have a dividend yield of 1.45 percent.

The shares trade for 10.5 times the consensus 2013 earnings per share estimate of $5.58, among analysts polled by Thomson Reuters. The consensus 2012 earnings per share estimate is $4.98.

UnitedHealth Group’s own outlook for 2012 is for earnings to “range of $4.80 to $4.95 per share and cash flows from operations to a range of $6.2 billion to $6.5 billion on revenues of $109 billion to $110 billion.”

According to a Bloomberg report on June 15, UnitedHealth Group hired Steve Larson — the current deputy administrator and director of the Center for Consumer Information and Insurance Oversight, part of the Centers for Medicare and Medicaid Services, who has been responsible for implementing Affordable Health Care Act rules — to become the company’s executive vice president for its Optum subsidiary.

Jefferies analyst David Windley rates UnitedHealth Group a “buy,” with a $71 price target, estimating “10 percent organic growth” for Optum, “while margins expand 150 (basis points) or so over the next three years.” The analyst also said that OptumRX, which will absorb UnitedHealth Group’s Medco prescription business in 2013, “leads the industry in quality,” and has the advantage of “UnitedHealthcare’s No. 1 position in government programs.”

Windley estimates that UnitedHealth Group will earn $4.97 a share this year, followed by earnings per share of $5.56 in 2013.

Express Scripts

Shares of Express Scripts of St. Louis closed at $52.14 Tuesday, returning 17 percent year-to-date. The stock is rated “B+” (good) by TheStreet Ratings.

The shares trade for 12 times the consensus 2013 earnings per share estimate of $4.37. The consensus 2012 earnings per share estimate is $3.53.

Jefferies analyst Arthur Henderson rates Express Scripts a “buy,” with a $68 price target, saying on Tuesday that investors should stop worrying about the pharmacy benefit manager’s contract dispute with Walgreen, since “the most material part of the 2013 PBM selling season — the part involving health plans and large employer accounts — is largely behind us with Express Scripts showing what appears to be a very high retention rate.”

In addition to seeing upside for Express Scripts if Walgreen comes to an agreement for a new contract, Henderson said “investors are underestimating ESRX's safety heading into Thursday’s Supreme Court ruling — this ruling will have no fundamental impact on ESRX’s business either way.”

WellPoint

Shares of WellPoint of Indianapolis closed at $69.10 Tuesday, returning 5 percent year-to-date. The stock is rated “A-” (excellent) by TheStreet Ratings.

Based on a quarterly payout of 28.8 cents, the shares have a dividend yield of 1.67 percent.

The shares trade for eight times the consensus 2013 earnings estimate of $8.54. The consensus 2012 earnings per share estimate is $7.78.

Leerink Swann analyst Jason Gurda on June 20 downgraded WellPoint to a “market perform” rating from “outperform,” saying the health-care benefits company’s stock was “trading in line with its average (price-to-earnings) multiple over the last five years, despite the uncertainty created by the Court.”

While not “making a specific prediction,” Gurda said his firm believes “that the risk that individual mandate could be overturned by itself cannot be ruled out, which could pose a potential near-term risk to the shares, and we would hold off on building any new positions. Our 12-month valuation range remains $81 to $85.”

The analyst estimates that WellPoint will earn $7.74 a share this year, followed by 2013 earnings per share of $8.54.

Aetna

Shares of Aetna of Hartford, Conn., closed at $40.68 Tuesday, for a year-to-date decline of 3 percent. The stock is rated “A-” (Excellent) by TheStreet Ratings.

Based on a quarterly payout of 17.5 cents, the shares have a dividend yield of 1.72 percent.

The shares trade for seven times the consensus 2013 earnings estimate of $5.59. The consensus 2012 earnings per share estimate is $5.06.

Wells Fargo analyst Peter Costa rates Aetna “outperform,” with a valuation range of $57 to $63, estimating the company will earn $5.00 a share during 2012, followed by earnings per share of $5.77 in 2013.

The analyst on Friday said that he had previously estimated that a new Medicaid contract with Ohio “could generate $500 million to $1 billion in revenues and potentially add $0.02 to $0.05 to (earnings per share) in 2013 for Aetna.” The company last week filed a motion for a temporary restraining order to stop Ohio’s Medicaid procurement process following the state’s rescission of its contract with Aetna after other bidders protested. According to Costa, Ohio rescinded the contract “given Aetna’s inability to provide evidence that it carried ‘full risk’ for lines of business in (Arizona, California, Maryland, and Texas)."

In support of his rating for Aetna, Costa said the company “has filled holes in its product suite through acquisitions and is now positioned for faster growth from sectors such as Medicaid, Medicare, health-care information technology, and international in addition to the continued improvements in earnings from pricing actions on the commercial business and from the development of narrow network products.”

—By TheStreet.com’s Philip van Doorn

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Disclosures:

TheStreet’s editorial policy prohibits staff editors, reporters, and analysts from holding positions in any individual stocks. At the time of publication, Rocco Pendola held no positions in any of the stocks mentioned.

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