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Gordon Pape
Gordon Pape

U.S. Health Care: Everyone Wins, Sort of; Buy Covidien Ltd. and CVS Caremark

April 17, 2010 | About:
Contributing editor Glenn Rogers joins us this week from southern California where as an expatriate Canadian he has watched the bitter U.S. health care battle with mixed emotions. Here are his thoughts about the outcome and two stocks he thinks will benefit. Glenn is a successful businessman, entrepreneur, and long-time investor. Over to him.

Glenn Rogers writes:

The year-long health care battle in Washington is finally over and as the dust settles it's time to contemplate what it all means for investors. Many of the readers of this newsletter are Canadian so I imagine that this partisan struggle must have been watched with interest, given the generally well-regarded public health system that has been in place in Canada for many years. That system is so well entrenched that is hard to imagine any circumstance in which Canadians would be willing to abandon it or even to alter the program in any significant way.

After this long and rancorous debate, Americans have been left with what amounts to a shadow of the original Obama plan. The legislation enacted by Congress maintains the uniquely American solution to health care which is very good for those who have insurance but extraordinarily expensive and getting more so every day.

As we try to figure out who will be the winners and losers in this new U.S. health care regime, it should be noted that the basic system remains intact. Yes, many of the new provisions are good and overdue such as eliminating denial of coverage for pre-existing conditions and extending coverage to millions more Americans. But almost nothing has been done to control costs so future legislators will have to tackle the problem again.

In my opinion, the only certain way to get expenses under control is to move to a single-payer system (in Canada it is the government). It is the sheer complexity and overlapping jurisdictions that force most U.S. doctors and other medical practitioners to maintain staffs that do nothing but deal with the various insurance providers. This complexity leads to all sorts of abuses and overbilling and these are likely to get worse under the new plan.

Having lived under both the Canadian and the U.S. systems I feel that a single-payer system similar to the one in Canada combined with the opportunity for enhanced coverage (in other words, a two-tier system for those who are willing to pay) would work well here in America. It's worth noting that Great Britain has taken exactly that approach for decades.

But enough editorializing. As far as I can see, the only losers in the new legislative package are high-income taxpayers. Single people earning more than $200,000 a year and married couples with an household income of $250,000 per annum will get dinged another 3.8% of their investment income. Otherwise, as far as I can tell most of the players in the existing health care system will do better in the years going forward than they did in the past. The reason for this is simple: they will have more customers who, because of the provisions of the legislation, have broader and deeper coverage. This will enable them to buy more goods and services from the health care providers.

Having said that, there are some health care segments that should do better than others. Hospital companies which currently provide services to uninsured people through their emergency rooms will now have many of those costs covered. However, in the end they are running a fairly tough business given high facility and staffing costs. In that regard, they are somewhat like airlines as investment vehicles and I don't think much of airline stocks.

Similarly, health care insurers will have more customers but will at the same time be forced to extend coverage to some categories of patients that they avoided like the plague in the past. Also, insurers are distrusted and disliked by most Americans as well as by politicians except when their lobbyists are supplying them with money during election years. Don't get me wrong: I think you can make money in hospital and health insurance stocks. But there are better places to take advantage of the new health care legislation without the political and structural overhangs that can be troublesome for this category.

One area I particularly like is big Pharma. I own shares and Eli Lilly (NYSE: LLY) and Abbott (NYSE: ABT) and given the nice yields on Eli Lilly in particular both the stocks deserve a place in your portfolio. But the two stocks I like best, albeit for different reasons, are Covidien (NYSE: COV) and CVS Caremark (NYSE: CVS). Here's the background on each.

Covidien Ltd. (NYSE: COV)[/b]

Covidien was spun off from Tyco International in July 2007. It's based in Ireland which I like because it gives the company broad international exposure and means it is not impacted by U.S. legislative changes as directly as some U.S. companies could be. Covidien generates over 40% of its sales from outside the United States and since spending on global health care is expanding rapidly, particularly in the developing countries, investors benefit not only from ObamaCare but also changes that are happening elsewhere in the world.

The company has 42,000 employees, 58 manufacturing facilities in 16 countries, and has a broad product line which includes medical devices, medical supplies, and pharmaceuticals. The well-diversified customer base is spread over 140 countries and includes hospitals, doctors' offices, long-term care facilities, and diagnostic centres. So by investing in this stock you get broad exposure to the global health care market while sidestepping the political noise that will be flowing around health care in America for years to come.

The company reported 2009 revenue of $10.7 billion (figures in U.S. dollars). Recently they announced a share buyback program that could see it repurchase up to $1 billion worth of common shares. The stock pays a quarterly dividend of 18c a share (72c annually). Results for the second quarter of the 2010 fiscal year will be released on April 21.

Action now: Buy with a target of $58. The shares closed on Friday at $51.09.

CVS Caremark (NYSE: CVS)

CVS Caremark offers good exposure to the aging population's needs for more pharmaceuticals, both proprietary and over-the-counter. As well, this drugstore chain is a play on improving economic conditions in the U.S. As the economy expands again, it should generate more spending by consumers on such CVS products as cosmetics and other high-margin merchandise.

The company has over 7,000 retail drugstores in 41 states and is not subject to the type of political scrutiny that most of its suppliers face. Caremark doesn't care what insurance provider its customers use or what particular medications they prefer because they sell them all. Also, the company has been opening in-store clinics where customers can receive basic medical care such as getting flu shots.

In addition to the retail segment, the corporation offers a pharmacy service unit that provides claims processing services for employers, insurance companies, unions, government employee groups, and many leading managed care organizations. Here again, the business is on neutral ground politically and should benefit from the general growth of overall spending on health care.

The stock trades at a 20% discount to its five-year historical average and pays a small dividend of 35c a year. Unlike Covidien, you don't get any international exposure with this company so you may want to take positions in both.

Action now: Buy with a target of $45. The stock closed on Friday at $37.14.

About the author:

Gordon Pape
Gordon Pape is the best-selling author/co-author of many acclaimed investment books, including the recently-published Sleep-Easy Investing (Viking Canada ). He is also publisher and editor of five investment newsletters, including the Internet Wealth Builder, Mutual Funds Update, The Income Investor, and The Canada Report, which was created specifically for U.S. residents interested in investing in Canada . He is a columnist for several magazines and websites and a frequently quoted media source. He has been a featured speaker at numerous events including the World Money Show in Orlando . His websites can be found at www.BuildingWealth.ca and www.TheCanadaReport.com.

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