The third-quarter earnings season is round the corner. Let’s find out how the health care sector, which includes diversified industries like managed care organizations, clinical, laboratories and diagnostics research, medical equipment, hospitals, and more, is likely to perform this time.
 
Since the start of this year, the managed care industry or the health maintenance organizations (HMOs), which includes the medical insurance group, has been displaying weakness. Factors like disappointing public exchange business, stringent regulations regarding the proposed mega merger of Anthem Inc. (ANTM) with Cigna Corp. (CI), and Aetna Inc. (AET - Free Report) with Humana Inc. (HUM), increasing medical ratio to name a few, have been the primary reasons behind the bearishness. Also, the different stance of the presidential candidates regarding the ObamaCare and the changes likely to be implemented upon getting elected, added to the uncertainty.

We note that the situation is no different in the third quarter. The Department of Justice has filed suits against the proposed mergers. The mergers, which were scheduled to be completed this year, have now been delayed. In fact, the closure of these deals is now shrouded with uncertainty.
This apart, issues related to the public exchanges business have been adding to the woes. Most insurers incurred losses from this business in the first half of the year and the trend is unlikely to reverse this quarter. Although insurance companies had expected better profitability in 2016 after making meager profits in 2015, the individual exchange business disappointed the firms. Major players incurred losses in this business and are now reducing their participation on the exchanges by exiting unprofitable markets.

However, all is not lost for this sector. In the quarter, HMO industry players are likely to have witnessed an increase in premium from the government businesses – Medicare, Medicare Advantage and Medicaid. A surge in the baby boomer population has led to higher demand for these policies. In 2015, about 55 million people were enrolled in Medicare. This number is expected number to climb to 75 million by 2026, courtesy of the aging of the baby boomers. Humana, Cigna, Aetna, UnitedHealth Group Inc. (UNH - Free Report) had earlier projected growth in their government business.

In addition, higher number of enrollees in the Medicare, Medicaid and Medicare Advantage businesses is expected to have driven membership growth in the third quarter. However, this upside might have been partly offset by a decline in membership on the public exchange business.

The insurers are also likely to see earnings growth on the back of their international operations. Players like Aetna, Cigna and UnitedHealth Group have extended their business worldwide in the wake of stringent regulations on the home turf. However, a strong U.S. dollar will be a drag on the quarterly earnings.

Moreover, strong balance sheets with low leverage and attractive organic cash flow generation, along with excess capital in the form of statutory reserves and parent cash continue to make this sector attractive.
 
Another healthcare sub sector, which provides clinical services for pets, is poised for growth as the veterinary market continues to strengthen. Also, healthy competition in the lab market continues to drive growth. Higher demand for veterinary services owing to increase in pet population, more knowledge and awareness, better medicines for pets, highly trained doctors, more technology, and improved diagnostics have been catalysts behind earnings growth of this sub sector.
 
Diagnostic and laboratory research companies are also slated to see earnings improvement owing to a greater health care access, which fuels demand for these services. Growth in the industry is influenced by aging populations and rising demand for preventive care and personalized medical treatments. Small medical labs are competing effectively by providing specialized analyses and establishing their presence in regions with fewer medical facilities.

Owing to these positives, we believe that the health care sector might still be a good bet as there exist some stocks that are likely to deliver positive earnings surprises this earnings season. 

How to Pick the Attractive Stocks?

Given the large number of industry participants, selecting stocks that have the potential to beat estimates appears to be a daunting task. Nonetheless, our proprietary methodology makes it fairly simple.

One way to narrow down the list of choices this earnings season is by looking at stocks that have the combination of a favorable Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) and a positive Earnings ESP. Notably, a positive Earnings ESP helps to identify stocks that have high chances of surprising estimates in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.

Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.

Below are five health care stocks that we believe are best positioned to stand out this earnings season.

UnitedHealth Group Inc. (UNH - Free Report) is a major health insurance company providing health insurance and health benefits services.  It has an Earnings ESP of +0.96% and carries a Zacks Rank #2. The company is slated to report third-quarter earnings on Oct 18. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

VCA Inc. (WOOF - Free Report) operates as an animal healthcare company in the United States and Canada. It operates through two segments – Animal Hospital and Laboratory. It has an Earnings ESP of +13.61% and carries a Zacks Rank #2. The company is slated to report third-quarter earnings on Oct 26.

Quintiles IMS Holdings, Inc. (Q - Free Report) provides biopharmaceutical development services and commercial outsourcing services in the Americas, Europe, Africa, and the Asia-Pacific. It has an Earnings ESP of +1.01% and carries a Zacks Rank #2. The company is slated to report third-quarter earnings on Oct 26.

ICON Public Limited Company (ICLR - Free Report) , is a contract research organization that provides outsourced development services to the pharmaceutical, biotechnology, and medical device industries in Ireland, rest of Europe, the United States, and internationally. It has an Earnings ESP of +1.7% and carries a Zacks Rank #2. The company is slated to report third-quarter earnings on Oct 20.

Aetna Inc. (AET - Free Report) operates as a health care benefits company in the United States. It operates through three segments – Health Care, Group Insurance, and Large Case Pensions. It has an Earnings ESP of +1.49% and carries a Zacks Rank #2. The company is slated to report third-quarter earnings on Oct 27.