Monday, April 13, 2009
Health care's "recession-proof" armor is starting to crack.
The Healthcare SPDR ETF (XLV) holds the largest drug and medical device companies in the world. It has outperformed the broader market by about 9% since the financial crisis began last fall. But some sectors of the industry have begun to deteriorate...
A recent report from the Maryland Hospital Association warned of falling income and rising expenses. The state's 34 hospitals lost a combined $466 million in the last quarter of 2008. It's a trend unfolding across the 5,000 hospitals through the U.S. Admissions are down and bad debt levels are rising as unemployment rates soar.
Hospital earnings are a leading indicator for the medical equipment and device sector. Falling earnings means less spending. As hospital budgets tighten, equipment and device makers are getting squeezed. Revenues will drop off a cliff this year. Growth rates will fall from historic levels around 6% to about 2%. So earnings will decrease faster than revenue... and in some cases, completely disappear.
The trouble's getting started already...
Natus Medical (BABY), an equipment maker specializing in infant-care products, reduced its 2009 outlook on January 20. But the company couldn't even hop the lower bar... On April 3, revenue came in 11% short of expected. Earnings dropped to 1 cent a share, 85% shy of guidance. Natus is not alone.
Hologic (HOLX), famous for its digital mammography systems, recently slashed its 2009 outlook. The company expects to have adjusted earnings about 10% lower than it forecast back in November. I doubt the company will even be able to achieve this lowered target. Don't be surprised if you see an additional earnings warning later this year.
Finally, robotic surgery maker Intuitive Surgical (ISRG), a one-time superstar in the medical-device industry, slashed guidance in January. The company expects sales of its "da Vinci" surgical system – at $1.5 million a pop – to remain stagnant.
Intuitive will report earnings this Thursday. The report will be a barometer for the sector. If Intuitive can't hit its reduced growth target (15%), I expect more downward guidance at other medical-device companies.
Intuitive's stock has already lost 65% of its value in the last six months. But if earnings disappoint, shares will likely drop into the $80s, a 15% decline from here. (Aggressive traders might consider scooping up some cheap April puts ahead of the announcement.)
Overall, I don't think the worst is over for the medical-device industry. I expect stocks to drop about 25% industry-wide. Even if the economy stabilizes, hospitals won't be interested in spending money on expensive equipment anytime soon.
So if you're looking for a safe place to park your money, avoid this corner of the heath care industry.
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