Investors looking for ways to profit from the country’s massive health care spending have taken an interest in HMS Holdings (HMSY), a small but fast-growing company that audits claims for Medicaid and other health care payers. And it seems many of these investors are expecting some pretty quick rewards.
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HMS makes money by catching erroneous and fraudulent payments by Medicaid and its other medical insurance clients. About two-thirds of HMS’s revenues come as a cut of the savings it finds, with the rest generated through fee-based service contracts. Its shares have had a great run in recent years, but they were knocked down hard last year when a couple of earnings reports disappointed. Third quarter results showed a 15% revenue gain and a 31% rise in profits. Due to arcane regulatory changes, processing of some of the claims it filed with insurers stalled last quarter, creating an unquantifiable backlog, and the share-deflating hit to earnings. And a jagged stock chart.
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That 40% drop last summer is indicative of the opportunity and the risk with HMS, a $2.25 billion market cap company now recommended as a buy by eight of the nine analysts who follows it. Its business model makes the company well-positioned to grow along with medical spending in the U.S., which is forecast to rise to 20% of GDP by 2021 from about 18% now.
But the stock is quite susceptible to even minor bad news. That “disappointment” in October that caused that last steep price drop? The company collected $92.4 million in quarterly revenue instead of previously-estimated $96.76 million. Its profits were slightly bigger than forecasts. This sensitivity is largely due to a share price jacked up on very large expectations. HMS shares carry a PE ratio of 54 and a price-to-sales ratio of more than 5 even now. These kinds of sustained ratios are rare even in the small cap world.
A lot of HMS investors believe the shares will look much better to Wall Street after its next earnings announcement, Feb. 15. While the current quarter numbers are expected to still be depressed, the outlook should be better. Post-election, the future for health insurance is clearer, and once-reluctant states are beginning to expand their Medicaid programs with the Affordable Care Act. In fact, Medicaid expenditures are expected to more than double by 2020. Fraud cost Medicaid and Medicare some $70 billion in 2010, according to the U.S. Department of Health and Human services, and combating such waste is a top priority for both public and private insurers.
Right now, HMS is the biggest Recovery Audit Contractor (RAC) for Medicare and Medicaid, having collected more than $1 billion for the agencies since 2009. It’s also the lead provider of coordination of benefits services for both. HMS’s competition is in large part small contractors like itself. But big players are interested in the territory, particularly when it involves non-government insurers. For example, Optum, one of HMS’s direct competitors, recently teamed up with analytics giant SAS to make fraud detecting services for health insurers. It’s a lucrative business, as one can see by HMS’s profit margins.
The company forecasts revenue growth of about 21% and more than 50% EPS growth in 2013 (fiscal year ends Sept. 30), which would go a long way toward justifying today’s share price. But you’d probably still have to steel yourself for the ride.
Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at firstname.lastname@example.org.