Health care diamonds in the rough
How one midcap value manager is finding bargains in an out-of-favor sector
NEW YORK (Fortune) -- Sifting through the rubble, sorting through piles of junk, bottom feeding - there are a lot of colorful ways to describe how value investors ferret out high-quality stocks that get socked when the market plummets or when an industry falls out of favor.
Fund manager Ragen Stienke has his own way of characterizing the opportunities he's seeing in the health care sector, which is getting the cold shoulder from some investors as Washington grapples with health reform.
"This is when we get excited, because we get to shuffle through the garbage and look for the diamonds that are thrown in there," says Stienke, who helps run the $121 million WHG SMidCap fund out of value veteran Susan Byrne's Westwood Holdings Group.
The fund, which is up 3% this year, held up better than most mid-cap offerings in 2008, falling 27% versus the S&P 500 index's (SPX) 37% drop. (The S&P 400 midcap index slid 36% in the same time period). While the losses stung, Stienke and his team have also been able to pick up some stocks they'd long coveted but considered too expensive until the recent market drop.
Now, as Congress prepares to debate health care reform, including massive spending cuts, the fund is on the lookout for industry bargains. "This sector is either ignored or hated by most of the market, because everyone's concerned about the health care bills," says Stienke. So the fund has focused on stocks that have been dragged down by uncertainty but are less likely to be affected by big cuts.
One of his favorites is Dentsply International (XRAY), a 100-year-old maker of dental products ranging from x-ray equipment to implants. Given its top market position, analysts believe Dentsply stands to benefit as the worldwide population ages, and its U.S. revenues don't depend on government reimbursements.
"It's unlikely to be subject to an overall health care bill, since they make things that dentists use in day-to-day operations, yet the stock has gotten hit along with the overall industry," says Stienke.
Another recent purchase for the fund, Natus Medical (BABY), has a similar profile: It's a leading player in a corner of the sector that won't bear the brunt of government cuts. The company develops products for the screening and treatment of medical conditions in newborns, including ailments like hearing loss and jaundice.
"That's not an item...that's likely to be subject to dramatic change in health care spending and reimbursements, which is an area we're trying to avoid," Stienke says.
At first glance, that would seem to be the risk with another of the fund's holdings, Amedisys (AMED), which provides home nursing services and hospice care. The company relies on government spending for the bulk of its business: In 2008, about 90% of its revenues came from Medicare reimbursements. Amedisys shares have dropped 22% so far this year amid concerns that home health reimbursements will be cut, but Stienke sees an opportunity to buy.
"The market's very worried that reimbursement rates could be significantly lower going forward, but we think that's largely priced in," he says. "What the market's missing is that providing health care at home means that the patient is not in the hospital, so the cost to the insurance provider or Medicare and Medicaid is lower."
That suits Stienke just fine. After all, what the market misses is where the value investor looks to gain.
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