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Need A Pill For That?

Neil George
Neil George
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When it comes to the new Medicare drug plan, it's been a headache for most folks, from the beneficiaries to politicians. But that’s not the case for investors who have the right prescription for profit.

It's supposed to be the first step in delivering relief for seniors and welfare recipients.

But for many, the plan hasn't gone as anticipated, resulting in confusion and troubles, particularly for low-income beneficiaries.

Now, any new government program is going to be wrought with initial buys that have to be worked out. But Medicare Part D provides two significant steps in healthcare and national health insurance.

First, it gives necessary coverage for the ever-increasing drug costs for those in financial need. Second, it does it through the private sector--not through a new federal bureaucracy.

This is causing the initial rub. The plan isn't about just completing a form and getting Uncle Sam to cut you a check.

Individuals are now decision makers for the first time, choosing medical care services. Marketplace competition (which has been limited until now) is alive; users choose plans based on their own needs and wants. The long-term goal: lower costs and better service as the market replaces--at least in part--the federal government.

Here, we'll look at how the plan will impact the drug and healthcare industry and how we can cash in on the prescription drug plan evolution.

Profit Three Ways

There are three core sectors that are already working to cash in on the Medicare deal: the private plan operators, the pharmacies and the drug makers.

Providing managed healthcare has been a great business to be in during the last several years. With ongoing increases in demand showing no signs of abating and little competition on rates, margins are solid to expanding.

Profits continue to flow in to the key members in this consolidating industry group. And investors who have been buying and holding these companies' stocks have seen their seed capital grow at an astounding pace.

Just take a look at the graph "Quite A Pulse." During the past five years alone, the managed healthcare group has seen an average price gain of more than 190 percent. Add in the dividend flows and the total return has almost doubled an initial investment in the sector.

The new Medicare plan is only going to complement what these companies have going on now. The key to the industry is numbers.

The greater the number of participants, the better these companies' margins and the lower risk of surprise benefit payouts. This has been leading to mergers and acquisitions as companies try to pull together the greatest sum of customers, including traditional non-Medicare and Medicaid participants from employee health insurance plans.

The Medicare plan adds to this. Everyone who is eligible for the new plan chooses a provider. If folks who are at or below certain income levels and are already eligible for drug benefits under the old Medicaid/Medicare programs don't choose, Uncle Sam will enroll them in a program.

The bigger the company, the more beneficiaries are assigned to it. This will only bolster the consolidation of insurers.

The leader of the pack is UnitedHealth. It grabbed PacifiCare, which continues UnitedHealth's expansion of its Ovations division.

PacifiCare was set to receive a large number of the assigned plan participants. Now those will flow to UnitedHealth. And all those AARP (American Association of Retired Persons) members are signing up with UnitedHealth through its Ovations unit.

The books are still being put together; but even before the deal, United Health's organic growth keeps climbing with revenues expanding at an average 20 percent-plus. Operating margins are already fat and expanding at near 40 percent, and they'll soar in the coming year as the drug plan unfolds. Make UnitedHealth your first buy up to 70.

WellPoint is putting its Blue Cross/Blue Shield businesses through the paces after grabbing Anthem. Like UnitedHealth's PacifiCare, WellPoint's Anthem has a lot of experience running drug plans for government programs (from state and local to federal levels).

It hasn't been without some teething pains. Some of the integration has weighed on costs and recent company performance. And some farsighted shareholders have begun to cash in of late.

Even with the past year's stock bounce, WellPoint remains cheaper than United Health and should at least match similar valuations. After grabbing a few shares of UnitedHealth, buy WellPoint up to 90.

Humana, like UnitedHealth and WellPoint, has lots of experience working with Medicare/Medicaid programs.

This has led to some great cash flows and challenges. Beyond the drug plans, Humana has its regular treatment programs under the Medicare/Medicaid payment umbrella.

With several cutbacks and limitations on how much Uncle Sam and states will pay for various treatments, Humana has always had to keep a tight lid on costs. That's led to a few stumbling blocks along the way.

But its stock is cheap. Shares are trading at a discount to rising revenues. Humana is worth your attention after our first two picks and is a buy up to 65.

The Locals

In the May 12, 2004, issue, we rolled out our call on the rising prescription drug market. The usual big pharma suspects with aging and troubled patented products (e.g., Pfizer and Merck) weren't going to make us wealthier and healthier.

Our focus was the local pharmacies. Since then, Pfizer, Merck and others have plunged by a third of their stock values, while our drug store buys have rallied by 30 percent-plus--more than doubling what the S&P 500 did for the same period.

We became worried that the drug plan could take some of the direct business away from the likes of our drug stores in favor of Internet or mail-order operations. But that fear isn't becoming reality.

Two factors support the local drug stores. First, many insurers will continue to run their drug distributions through select pharmacy companies around the US. Second, a big chunk of beneficiary customers have been asking their local pharmacist which plan to go for, and you can imagine the answers they've been getting.

Walgreen's is king, a leader in drug sales and ancillary products. As more seniors pick up their pills there, they're more likely to purchase other necessities.

The company is solid, with sales gains consistent year in and year out. And with increasing demand for pills from all customer groups, including Medicare plan participants, look for its double-digit gains to remain on track.

Valued at the sum of trailing sales, Walgreen's is a reasonably safe investment on growing drug sales. Buy Walgreen's up to 45.

Wal-Mart is a competitor. But with other baggage, we sold it and will continue to stand aside from this otherwise impressive company.

CVS, though, is in line with Walgreen's. It has similarly steady sales growth, which will only gather steam with its further integration of Eckerd's units from troubled retailer JC Penny's.

CVS will continue to pile it on for investors as the Medicare plan ensues. Trading at a discount to its trailing revenues, CVS is slightly cheaper than Walgreen's and is a buy under 32.

There are two other speculative plays with select market participation--Long's Drug Stores and Rite Aid. Buy these two in small batches after your initial investment in Walgreen's and CVS.

Both will make for great grabs by another retailer or an insurer looking for more direct participation. Either way, buy a few shares of Long's up to 40 and Rite Aid, which is in recovery, up to 5.

Pill Pushers

We remain critical of the big patent drug companies, given their continued challenges, which range from a meager pipeline of new product to legal woes and super high stock valuations.

But we continue to recommend Growth Portfolio members Bayer and Teva. These companies have the right mix of generic drugs on top of their company efficiencies. Despite both companies' impressive steady share gains, they remain bargain buys compared to their better-followed US peers. Buy Bayer up to 50 and Teva under 47.

Neil George will be available to take your questions until Monday, February 20. Please use the form below to submit your questions.

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