HealthSouth Corp (HLS), Kindred Healthcare, Inc. (KND): The Real Healthcare Killer

Healthcare is becoming the David Bowie of the stock market.

Yes, this industry is going through some major ch-ch-changes right now. From day to day this industry is looking a bit different then it did before, but the biggest changes probably aren’t where you’d expect.

The biggest change isn’t healthcare reform. The industry is actually experiencing much greater turmoil from a severe labor shortage that is set to get much worse.

People matter more in healthcare than in other industries. Patients tend to think they have a one on one relationship with their caregiver, and they’ll change hospitals to follow them. Healthcare workers have also always been in high demand. But with increases in life expectancy, advances in technology, and an aging baby boomer population, this killer shortage is ready to rumble.

A recent report from the Bureau of Labor Statistics found that healthcare will be the fastest growing industry through 2020. Skilled healthcare is set to add 5.6 million jobs, growing between 25%-30%, more than double the overall job market average. While that’s great news for healthcare workers, it should be a concern for investors who own HealthSouth Corp (NYSE:HLS) and Kindred Healthcare, Inc. (NYSE:KND).

As if Kindred Healthcare, Inc. (NYSE:KND) and HealthSouth Corp (NYSE:HLS) didn’t have enough to worry about with new healthcare laws and medicare cuts, now they have to worry about a worsening labor shortage!

Let me paint you a frightening picture. These businesses own inpatient rehabilitation and long-term care facilities that rely heavily on medicare. With more medicare cuts looming, and drastic cuts a real possibility, these businesses already were going to see their margins shrink further. Perhaps HealthSouth Corp (NYSE:HLS), which has margins near 20%, will be better prepared to weather the storm than Kindred Healthcare, Inc. (NYSE:KND), which has a gross margin of 1.5%. But given HealthSouth Corp (NYSE:HLS)’s history of fraudulent accounting, investors may not trust that 20% figure.

HealthSouth Corp (NYSE:HLS)’s shady past included rampant CFO turn-over due to management pressures to “fix” poor results. As I’ve stated before, long after the scandal (as recently as last December) the stock traded at a multiple below 10 due to lingering investor worries regarding this issue. Do I think HealthSouth Corp (NYSE:HLS) still has shady accounting? No. But I do think that with the stock at 52 week highs, while facing a plethora of other concerns, investors as a whole may get skeptical right here.

Now, when you factor in that physical therapists vacancies are set to lead the nations hiring, followed closely by nurses, Kindred Healthcare, Inc. (NYSE:KND) and HealthSouth have real problems. After all, both of these businesses have seen salary costs increase each of the past three years even as revenues remained stagnant. HealthSouth, in particular, has seen a sharp increase in labor costs of 12%.

I could tell you to sell these stocks because they’re both trading near 52 week highs. I could also tell you that neither are trading at particularly attractive valuations anymore. But those aren’t the real reasons to consider selling.

You already know that stock picking isn’t always as obvious as screening for “multiples,” and that’s the case here. That’s why investors should look at research from outside sources that impact industries, like the aforementioned BLS report.

Extreme shortages of physical therapists and nurses will impact these companies because they will have to spend more money on salaries and recruitment costs. That’s real cash that will come out of their already slim margins.

I’m not saying to sell the stocks on this news alone, but be aware of these changes and tread lightly. Both stocks have nearly doubled in price this year, outpacing the market overral, and HealthSouth trades at a multiple of 16, while Kindred Healthcare, Inc. (NYSE:KND)’s forward PE is at 11. They may have too many concerns to rally hard from here.

Much of AMN Healthcare Services, Inc. (NYSE:AHS)’s business is based on temporary or long-term temporary placement of nurses, which should see a boost at some point. Many nurses are temporary or part-time workers, a lot of stay at home parents pick up shifts in this field. So when the recession hit, an influx of nurses who had been “on the sidelines” came back to work. That trend was actually pretty consistent in most areas of health care that offer flexible schedules such as nursing, pharmacy, and therapy. The jobs all became much more scarce when the temps came off the sidelines.

Now many of those nurses and pharmacists are cutting back on their shifts at a time when other factors are causing demand to increase anyway. That’s good news for AMN Healthcare Services, Inc. (NYSE:AHS) and its army of skilled healthcare workers. I believe that this demand should help AMN Healthcare Services, Inc. (NYSE:AHS) charge higher margins to hospitals and rehab facilities in the coming years.

The stock has been on a tremendous run, tripling just this year. But at 34 times earnings, it’s probably too hot to buy today. Remember that this is a long-term trend, supposedly going through 2020. AMN Healthcare Services, Inc. (NYSE:AHS) is a wonderful business with great long-term growth potential. I recommend putting it on your “short-list” for a pull-back–I know it’s on mine!

So there you have it Foolish Investor, this little labor report has enough in it to change the face of healthcare. Isn’t that amazing?

To me it’s just a clear reminder that sometimes what happens to a company matters more than what happens inside of it. You should be aware of all the outside factors that can impact the stocks that you own. If you own stocks in a “people business,” like healthcare, labor reports are a great place to start.