Private Equity Putting Money Into Health Care

 | Feb 22, 2017 | 12:00 PM EST
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It should be no surprise that private equity firms like KKR are considering health care companies. Health care has been the most consistently growing sector of the economy for some time, and that is not going to change. About 14% of the population is 65 or older, and the number is growing every day. According to the Administration on Aging, that will increase to over 21% of the population by 2060. Life expectancy is increasing and is close to 80 years and growing as we have new medical breakthroughs that cure or reduce the impact of certain diseases and conditions. I can tell you from personal experience that the older you get, the easier things break, and the more you will have to spend on health care.

I have spent some time this week searching for health care companies that are trading at a reasonable valuation and may be candidates for a long-term private-equity mindset portfolio. As I said yesterday, there are not many, but in addition to Fonar (FONR) , the company I wrote about yesterday, there are a few financially sound health care companies with decent prospects trading with reasonable rations of enterprise value to earnings before interest and taxes.

I like Psychemedics (PMD) a lot and am surprised it has not been purchased by a larger concern. The company provides testing services for the detection of drug abuse through the analysis of hair samples. The company can test for drugs like cocaine, marijuana, phencyclidine, methamphetamines and opiates like heroin and Oxycodone. They provide services to law enforcement agencies, schools, employers and, of course, concerned parents. Drug use can be seen over a much longer timeframe using hair samples rather than blood or urine. The company has been growing at a decent pace, and over the next five years the handful of analysts who follow the company expect earnings growth to be around 20% annually.

The stock has been volatile lately after it was announced that the company's Brazilian distributor was being fined for anti-competitive practices. The stock sold off sharply, but Psychemedics was quick to remind investors that Psychemedics Brasil is a distributor and the company does not own any of the Brazilian firm and anticipates no change in its Brazilian business as a result of the action. The Brazilian business is, in fact, quite robust. Brazil recently passed a law that requires all professional drivers to be drug tested, and that has helped boost international sales and profits of testing services.

After the selloff, the stock is reasonably priced with an EV/EBIT ratio of just 9.1. Fundamentals and prospects appear to be sound as Psychemedics earns an F-score of 7. Drug abuse is not going away, and we will see more testing in the workplace and schools in the future. If this company can hit the earnings increase estimate, and I think it can easily, then this stock should do very well over the next five years. You also collect a dividend that yields about 2.9% at the current price

Span-America Medical Systems (SPAN) also makes the list of private-equity mindset health care companies. This is not a cutting-edge medical company, but it should see steady demand. The company makes beds, chairs and support devices for the health care industry that are designed to reduce pressure ulcers. They sell these to hospitals and long-term-care facilities throughout the U.S. and in Canada. It also has a custom products segment that makes beds for the consumer market and engineered-foam products for industries including autos, packaging, electronics and water sports equipment.

It may not be the most exciting business, but it should be a steady business for a long time to come. An aging population is going to need more long-term care, and that is going to create demand for Span-America's products. You do get paid while you own the stock as it yields over 3% and management has been growing the payout by an average of about 9% annually. I also like the fact that insiders have substantial skin in the game, owning about 17% of the shares.

Health care is going to be a growth leader for a long time and a source of several 100-to-1 stocks. Right now bargains are hard to find, but that will change when market conditions do, and investors would be wise to track the sector.

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