(By Philip Guziec) We use Morningstar's proprietary
industry-level data to find sectors and industries that are attractive
for option-based investment strategies.
The charts below show how much the average implied volatility
for each sector differs from its trailing three-month and trailing
one-year averages for U.S.-listed equity options (vertical bars, indexed
on the right-hand scale) and the change in implied volatility from week
to week (dark blue line, indexed on the left-hand scale).
Implied Volatility Declined Broadly Across Industries, Rising Only Slightly for Real Estate Companies
Our sector standout chart below shows how much the average
implied volatility for each sector differs from its average during the
last year and last quarter. Vertical bars (indexed on right-hand scale)
show present sector volatilities with respect to historical averages.
The dark blue line (indexed on the left-hand scale) shows change
relative to the previous week.
Source: Morningstar Option Research
Implied volatility of health-care companies is nearing
year-long lows. This may be an opportunity to buy bullish option
exposure to undervalued names, including those listed below.
Source: Morningstar Option Research
Founded in 1986, VCA Antech is the largest operator of freestanding,
full-service animal hospitals and veterinary diagnostic labs in the U.S.
With about 528 pet hospitals and 2,100 vets, the firm handled 6.8
million patient visits in 2010. It traded publicly from 1991 to 2000.
After the company ran up a huge debt load to fund a buying binge in the
late 1990s, a private-investment group purchased and recapitalized the
firm. VCA Antech went public again in 2001.
While the pullback in pet health-care spending has bottomed out, we
have not seen a resumption of robust growth. Our thesis on VCA Antech
primarily rests on our belief that consumers eventually will feel
confident enough to spend on nonacute, preventive care again, allowing
the firm to grow at the 8% historical pet market rate. We expect a
gradual recovery for VCA during the next few years, contingent upon
incremental improvement in unemployment.
Despite potential near-term bumpiness, we appreciate that VCA is
poised to benefit from longstanding trends in greater pet ownership and
consumer attachment to pets that can translate into a willingness to
spend on pet health care. Furthermore, the growing application to the
pet market of technology initially developed for humans will increase
the sophistication and cost of pet health services.
WellPoint is one of the largest U.S. health insurers by medical
membership, serving 34 million people. It holds the exclusive license to
the Blue Cross and/or Blue Shield names in 14 states, including
California, Georgia, New York, and Ohio. WellPoint's business mix is
weighted toward the commercial market, with a particular focus on
small-group coverage. Approximately 40% of members are in traditional
risk-based products, with the remaining 60% in fee-based products.
WellPoint's 14 Blue Cross and Blue Shield plans provide the company with
a unique combination of regional and national scale. The former is the
key to negotiating favorable provider rates, while the latter is
essential for leveraging administrative costs.
Investors remain fearful about the regulatory headwinds facing
WellPoint, causing the stock to trade for 8 times earnings and with a
40% discount to our fair value estimate. However, we think these
concerns are overblown, as the recent health reform law should have only
a modest impact on WellPoint's future profits.
Although we expect ongoing medical cost pressure, this should be
partly offset by revenue growth opportunities and potential SG&A
leverage. In the meantime, WellPoint generates copious free cash flow,
which it is using to repurchase shares at a breakneck pace.
Express Scripts is the largest pharmacy benefit manager in the United
States. Through its mail-order pharmacy and network of retail
pharmacies, we expect Express Scripts to administer around 1.5 billion
adjusted prescriptions in 2013.
We expect pharmacy benefit managers like Express Scripts to enjoy a
bevy of positive trends in the next several years. Industry
consolidation, the aging population, a slew of patent expirations for
brand-name drugs, health-care cost-containment efforts, growth in the
number of people with insurance as a result of health reform, and
increasing customer acceptance of mail-order pharmacies all bode well
for Express Scripts. With the merger with Medco now complete, we believe
Express Scripts has a wide economic moat.
Express Scripts has a history of successfully integrating
acquisitions, and we see no reason Medco will be any different,
particularly since we already consider the company to be very well run.
Express Scripts now has more than 100 million members and controls
around 35% of U.S. pharmaceutical spending. It dwarfs second-place CVS Caremark(CVS),
which is likely to find it nearly impossible to catch up, given the
lack of other possible acquisition targets of size. Other suppliers and
competitors--such as retail pharmacies, distributors, and smaller
PBMs--risk seeing their own margins compress, to Express Scripts'
Philip Guziec, CFA, is Morningstar's derivatives investing strategist. He leads Morningstar's OptionInvestor
service, which applies Morningstar's fundamental research methodology
and fair value estimates on 2,000 stocks to uncover option investing
opportunities. Guziec joined Morningstar in 2003 after a career as an
engineer and management consultant.