A decision regarding the constitutionality of the health care reform law is expected by the Supreme Court in mid-June 2012.
Below, we discuss some potential actions by the Court and the impact we think they could have on various health care industries. We also look at the impact on Health Care Select Sector SPDR Fund (XLV), the largest health care ETF by far with $4.4 billion in assets.
There are three potential scenarios arising from the Court decision, says Jeffrey Loo, head of health care equity research for S&P Capital IQ.
The best scenario for the health care industry, he says, would be a ruling that the individual mandate is constitutional, allowing the health care reform law to be implemented as scheduled.
Under this scenario, the health care sector would benefit from approximately 32 million additional insured customers (phased in from 2014 to 2019), positively impacting health care facilities, managed health care companies, health care service providers, and health care distributors.
Another scenario is the Court rules the individual mandate unconstitutional and cannot be severed from the rest the Court would invalidate the individual mandate along with the rest of the health care reform law package.
S&P Capital IQ believes this scenario would have a neutral impact on the overall health care industry. In spite of losing its largest potential growth driver (the 32 million additional insured Americans), burdensome concessions, regulations, fees, and taxes would likely be dropped as well.
The last scenario is the Court ruling the individual mandate is unconstitutional, but leaving the rest of the health care reform law package intact. S&P Capital IQ believes this would be the worst-case scenario for health care companies.
Under this scenario, the concessions, regulations, fees, and taxes various sub-industries agreed to in exchange for the potential of 32 million additional insured Americans would remain, unless new legislation scales them back.
The Congressional Budget Office estimates that if the individual mandate is struck down, only 16 million additional Americans would obtain insurance, with the vast majority coming from the expansion of Medicaid (assuming the Court determines the expansion of Medicaid is lawful anyway).
Medicaid customers generate the lowest margins for the health care sector. Loo believes the companies most adversely impacted would include health care facilities, pharmaceuticals, managed health care, and health care services.
As of April 2012, 51% of the assets in XLV were in pharmaceuticals, including five of its 10 largest holdings: Abbott Laboratories (ABT), Bristol-Myers Squibb (BMY), Johnson & Johnson (JNJ), Merck (MRK) and Pfizer (PFE). These stocks all earn our buy rating.
Herman Saftlas, the equity analyst who covers these stocks for S&P Capital IQ, believes that pharmaceuticals would be among the groups most affected by any decision, with the likely impact less pronounced for the managed care and hospital areas.
Overall, Saftlas favors the aforementioned stocks for their growth potential and generous dividend yields.
The next two largest sub-industries in XLV are health care equipment (16%) and biotechnology (11%). S&P Capital IQ equity analysts are more positive on the fundamentals of biotechnology than equipment and have a buy recommendation on Amgen (AMGN).
Rounding out the five largest sub-industries for XLV are managed health care (9%) and health care services (5%), with respective holdings such as S&P Capital IQ buy recommended UnitedHealth Group (UNH) and strong buy recommended Express script Holdings (ESRX).
Overall, despite the overhang of the Supreme Court review of healthcare reform, we think the Health Care Select SPDR Fund is worthy of investor attention.
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