A Victim of the Coming Baby Bust

06/25/2008 12:00 am EST

Focus: STOCKS

Michael Shulman

Editor, Short-Side Trader

Michael Shulman, editor of ChangeWave Shorts Alert, says a company that treats infants with special medical needs may suffer if births drop in a weak economy.

Historically, a forecast of a recession also means a forecast for reduced baby-making, and there's one company in particular that will suffer.

Pediatrix Medical Group (NYSE: PDX) manages a nationwide network of more than 1,100 physicians focusing on neonatal, what it calls “maternal-fetal,” and other pediatric specialties. Almost 800 of these doctors are neonatal specialists.

Simply put, Pediatrix runs or owns the specialty units in many hospitals that take care of difficult births and infants with special needs, such as cardiac care. PDX has been at it a while, having begun in 1979 in Florida.

The business has grown organically, but acquisitions using a steadily rising stock as currency are the keys to current and future growth—and, well, that party’s over.

Pediatrix will not enjoy organic growth, as many people forego making babies during recessions. Yes, we are in a recession—forget the official statistics; just go to the mall or a car dealership or a new housing subdivision.

But the problem runs a bit more deeply than that for Pediatrix:

• A higher percentage of at-risk babies come from lower-income parents and, despite popular myths, births in lower-income groups drop the most during a recession.

• The last baby boomers have stopped having kids—and they experienced a high percentage of difficult births.

• Difficult multiple births are directly tied to the rate of fertility treatments and these, too, have been going down in the face of a slowing economy, as many of these treatments are not covered by insurance.

• The next president is going to, at a minimum, increase coverage for children in Medicaid. But at the same time he is also going to reduce reimbursement for almost everything else, including neonatal care.

In the first quarter, the company missed guidance due to shrinking business at its existing practices. And in May, it lowered expectations for the worst of all reasons (for us, the best)—as it has no organic growth opportunities. This means Pediatrix can grow only through acquisitions, and it will have a hard time buying practices with a falling or unsteady stock.

Pediatrix's current valuation is reasonable—about 15x current earnings—but analyst expectations are way too high.

The company [also announced] a stock buyback. That it intends to spend $100 million on a buyback rather than use cash to buy practices means the lure of stock is the key to expansion. That is not a good thing in the current environment.

Pediatrix has short-, mid- and long-term problems to kick-start growth and cash flow. I recommend buying the PDX November $50 Puts (PDXWJ.X) under $3.00. (The stock closed above $51 Tuesday, and the options changed hands at around $4.30. Short selling is only for extremely risk-tolerant investors who can afford to lose the money they’re putting up—Editor.)

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