When Regulation Spells Opportunity

The US health care industry is among the heaviest regulated in the nation. Most health care-related companies must answer to federal, state and, in many cases, local regulators.

That regulatory burden will only grow more complex, as myriad new rules under the Patient Protection and Affordable Care Act, or “Obamacare,” come into effect over the next few months. In just 22 days, the first insurance exchanges are supposed to come online. On January 1, the individual mandate and changes in coverage standards become effective.

Many health care businesses and organizations were dragging their feet in complying with Obamacare’s provisions, waiting to see how the Supreme Court would come down on the law. The court didn’t rule on Obamacare until June 2012, a decision in which it upheld the law almost in its entirety.

Given that delayed decision, a study conducted by the Government Accountability Office this past June found that only 44 percent of key activities required for full compliance had been completed, particularly where health insurance exchanges were concerned.

As a result, there’s a massive scramble underway to achieve minimum compliance levels with the law. But there’s a paucity of workers with the requisite knowledge of federal and insurance regulations required to help companies and state governments navigate the labyrinth of regulations.

That’s creating a lot of work for consultancies such as Huron Consulting Group (NSDQ: HURN), which focuses almost exclusively on the health care sector.

While the company also works in the legal, financial, education and life sciences arenas, it primarily helps hospitals, health systems and physician groups reduce costs, maximize reimbursements from both federal and private insurers and transition towards the value-based care mandated under Obamacare. In future years, reimbursements will transition towards rewarding health care organizations that achieve results rather than just provide services.

As the pace of adaptation has picked up ahead of next year, Huron grew earnings 131.7 percent year-over-year in 2011 and 71.6 percent last year. In the second quarter, earnings were up 137.9 percent year-over-year, reaching $0.71 in earnings per share (EPS).

For full-year 2013, EPS is forecast to total $3.08 on revenue of $640 million, with a further 16.2 percent EPS gain to $3.58 in 2014 on $730 million.

In addition to a low debt-to-equity ratio of 0.3, Huron also throws off free cash flow of about $3.50 per share in an average year. Much of that free cash is being put towards retiring debt, with long-term debt falling from $257 million in 2011 to $194 million last year. That has left the company cash poor, with just $5 million on the balance sheet, representing one of the company’s few blemishes.

Despite being one the strongest business consulting companies, the company’s shares are currently trading at just 19.2 times trailing earnings versus an industry average of 27.2 times. The stock also trades at just 14.5 times forward earnings, although there isn’t a significant discount in terms of prices to sales or cash flow.

The rush to get health insurance exchanges up and running is also benefiting Towers Watson & Company (NYSE: TW).

The company is heavily involved in the health insurance business, although it provides a number of consultancy services that cover human resources issues such as talent recruitment and retention, as well as actuarial and risk management geared towards the insurance industry.

Several large pension plans, including most recently the one offered by IBM (NYSE: IBM), have found it increasingly expensive to provide health benefits to retirees through company-sponsored health plans.

Consequently, they have begun offering retirees a fixed sum of money to purchase their own health insurance. The pension plans then contract with Towers Watson, which runs a private health insurance exchange known as OneExchange, to offer coverage options.

Federally mandated public health exchanges are encountering difficulties getting started, but the OneExchange network is an excellent example of how the private sector is filling the gap. That’s gotten the government’s attention, which recently contracted the company to help steer consumers into the 36 state health insurance exchanges that will be operated by the federal government.

For the company’s latest fiscal year ended in June, revenue was up 5.2 percent while EPS was up 24.2 percent year-over-year.

But like Huron, Towers Watson trades at a discount to its industry, commanding a price-to-earnings multiple of just 19 versus the average of 27.3 for its peers. That’s despite the fact that EPS is expected to reach $6.45 in fiscal 2014, for growth of 44.6 percent, and increase another 13.5 percent in fiscal 2015 to EPS of $7.32.

Wall Street is clearly still taking a wait-and-see approach to both Huron and Towers Watson given their lower multiples, but with Obamacare here to stay there are profits ahead.