Short Hospital Systems, Buy Health Insurers: Humana Inc. (HUM), HCA Holdings Inc (HCA)

As a health care provider, I see big changes coming with the implementation of the Obamacare law coming in 2014. By looking at some likely scenarios you can position yourself to benefit from the changes taking shape.

In 2014 the individual mandate will come to fruition bringing many more clients to insurers, and this will likely manifest itself in higher deductible health insurance plans and the expansion of Medicaid enrollees. These trends bode well for insurers, since they will gain more revenue as their pool expands.

Some companies to consider in preparation for 2014.

Humana Inc (NYSE:HUM)Humana Inc. (NYSE:HUM) sells for a PE of about 11 and carries a 1.3% dividend yield; it recently announced earnings that beat analyst estimates and issued guidance that was rosier than expected. Humana should benefit from those additional revenues coming in 2014.

Another company in a similar situation is UnitedHealth Group Inc. (NYSE:UNH), which was recently upgraded by Goldman Sachs Group, Inc. (NYSE:GS) in anticipation of changes occurring in the health insurance marketplace. United Health also has a reasonable valuation with a PE less than 11 and a dividend yield of 1.5%.

Humana and United Health represent 2 premium names that lead as HMO insurance carriers and are well diversified in terms of the products they both offer.

On the flip side of the equation are hospital systems. I believe that the trends are going to work against them as they have to suffer lower margins with the increase in Medicaid enrollees, and there are other trends that will affect the bottom line.

The scariest trend is that of RAC audits by Medicare. RAC audits go over records and then withhold payment if the documentation does not support the services. Even when the hospitals win the appeals their payments are significantly delayed. At Memorial Hermann in Houston they went from being paid in 14 days to greater than 200 days and had to add a new office costing more than $750,000 to deal with the audits.

Private insurers such as Humana and United Health are sure to follow Medicare. More overhead costs and delayed payments will equal decreased profits for hospital systems.

Community Health Systems (NYSE:CYH), based in Franklin, TN, may be on the wrong side of the health care trends. They operate mostly rural hospitals in 29 states. It sells for a higher PE than the insurers, close to 15 and pays no dividend.

HCA Holdings Inc (NYSE:HCA), which is based in Minnesota and operates hospitals in 20 states, at least boasts a lower valuation with a PE less than 6, but no dividend. Its last earnings were short on the revenue side and beat estimates on the EPS side, but the trends are not exactly good as net margins contract.

The bottom line is that hospital stocks such as CYH and HCA will be encountering increasing pressure to cut costs as their rates of payments for services shrink. In addition, Medicare, Medicaid and insurers will increasingly turn to audits in order to recover monies paid with inadequate documentation or delay payments. Overall I foresee insurers coming out much better in 2014 than hospitals.

The article Short Hospital Systems, Buy Health Insurers originally appeared on Fool.com and is written by Erick Santos, M.D., Ph.D..

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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