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Obamacare May Curb Lab Test Pricing

Your Money: Obamacare spurs sale of medical lab stock

 Published Tuesday, August 27, 2013 (Inquirer.com behind sub wall)

Last year, I interviewed Robert Zagunis, portfolio manager of the Jensen Quality Growth Fund, in the middle of Hurricane Sandy.

I recently caught up with the money manager, a University of Pennsylvania alum, to ask whether he’d made any big changes to his portfolio, particularly given that the stock market has had a terrific run since then.Back in the 1960s, Zagunis trained under Penn and Olympic rowing coach Ted Nash.

Today, Zagunis and his crew at Jensen screen for companies above $1 billion in market capitalization and a return on equity of 15 percent or more for each of the last 10 years. The higher the return on equity, the better, as high ROE companies produce more earnings and free cash flow that can be used to support a higher level of growth and keep the companies financially strong.

Since last year’s interview, Zagunis says, he and his Jensen Quality Growth Fund have added to some of their holdings, companies such as Procter & Gamble and Medtronic, but sold only one major position: Laboratory Corporation of America Holdings.

The main reason? Changes rendered by President Obama’s Affordable Care Act, known as Obamacare, and a new government report outlining the need to cut lab costs.

“We sold LabCorp as we anticipated pricing pressures by government decree,” Zagunis says. LabCorp does “a lot of Medicare and Medicaid business. Now, the government is asking for lower prices. Volume is important, and so are the margins on that volume. The impact was so unclear, so we sold our position.”

In short, he says, “the politics changed.”

Medicare is the largest payer for clinical-laboratory services in the nation. It spent about $8.2 billion for lab tests in 2010, which accounted for 3 percent of all Medicare Part B payments, according to a Department of Health and Human Services inspector general’s report in June. Prior to that evaluation, there had not been a comparison of Medicare payment rates with those of other health-care service payers.

In his report, Daniel Levinson, the HHS inspector general, wrote: “The lab test payment rate structure is outdated and should be changed.” (See the full report athttp://1.usa.gov/18VOiJ.)

Quest Diagnostics Inc. and LabCorp, the two largest lab-services companies in the United States, each receives at least 15 percent of its annual revenue from Medicare, according to Bloomberg data.

In the broader stock market, Zagunis notes, “the correlations have decoupled. Europe has decoupled from the U.S., China from the rest of the world. There’s more of a stock-portfolio effect going, and more stability [in the markets] as each country addresses its own problems.”

Among Jensen fund’s portfolio companies, “there’s softness in the top line [sales], but cash flows remain very good,” he says.

Jensen Quality Growth Fund’s other top holdings as of June 28, the most recent filing available, include companies such as 3M, United Technologies, PepsiCo, Oracle, Omnicom Group (which recently announced a merger with Publicis, its biggest rival), Automatic Data Processing, Colgate-Palmolive, Microsoft, and Praxair.

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