Which Hospital Operators Will Thrive Under ObamaCare?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

At the end of 2011, when I was looking for investment opportunities in the US, I stumbled onto one decent hospital operator that had continued to increase operating cash flow. However, I did not initiate a position because of its high leverage level. That company is Community Health Systems (NYSE: CYH). When I first looked at it, CYH was trading for only $16 - $17 per share. Now, I feel I may have missed out, as it has already advanced to more than $30 per share, a gain of 76% - 87% in less than a year. So, with a $30 price tag, is CYH still a good investment? 

CYH, founded in 1986, is in the business of providing healthcare services via 131 operated hospitals with nearly 19,700 beds in 29 states in the US. The occupancy rate in terms of beds in service has fluctuated in the last 3 years. The revenue from inpatient and outpatient services has been relatively evenly divided during this period. In 2011, the inpatient revenue was 46% of total revenue, whereas the outpatient revenue accounted for 52%. Over the years, CYH has generated increased revenue, operating income, and operating cash flow

<table> <tbody> <tr> <td> <p><em>USD million</em></p> </td> <td> <p><strong>2002</strong></p> </td> <td> <p><strong>2003</strong></p> </td> <td> <p><strong>2004</strong></p> </td> <td> <p><strong>2005</strong></p> </td> <td> <p><strong>2006</strong></p> </td> <td> <p><strong>2007</strong></p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> </tr> <tr> <td> <p><strong>Revenue</strong></p> </td> <td> <p>2,200</p> </td> <td> <p>2,835</p> </td> <td> <p>3,333</p> </td> <td> <p>3,738</p> </td> <td> <p>4,366</p> </td> <td> <p>7,127</p> </td> <td> <p>10,840</p> </td> <td> <p>12,108</p> </td> <td> <p>12,987</p> </td> <td> <p>13,626</p> </td> </tr> <tr> <td> <p><strong>Opt. Income</strong></p> </td> <td> <p>242</p> </td> <td> <p>291</p> </td> <td> <p>339</p> </td> <td> <p>406</p> </td> <td> <p>380</p> </td> <td> <p>486</p> </td> <td> <p>984</p> </td> <td> <p>1,069</p> </td> <td> <p>1,115</p> </td> <td> <p>1,134</p> </td> </tr> <tr> <td> <p><strong>Opt. CF</strong></p> </td> <td> <p>285</p> </td> <td> <p>244</p> </td> <td> <p>326</p> </td> <td> <p>411</p> </td> <td> <p>350</p> </td> <td> <p>688</p> </td> <td> <p>1,057</p> </td> <td> <p>1,076</p> </td> <td> <p>1,189</p> </td> <td> <p>1,262</p> </td> </tr> </tbody> </table>

The 10-year annualized growth of its revenue, operating income, and operating cash flow was 20%, 16.7% and 16%, respectively. That’s quite a record of growth.

What worried me, was the high debt level that CYH is carrying and its high level of goodwill. As of September, CYH’s total stockholders’ equity was $2.65 billion; the cash on hand was only $241 million. The long-term debt increased to nearly $9.5 billion, along with nearly $4.4 billion in goodwill. That leads to a negative tangible book value of nearly -$20 per share, whereas the shares are currently trading at $30, with a total market capitalization of $2.74 billion. However, with 1.94x interest coverage, CYH is in decent position to pay back its interest expense on its debt. 

President Barack Obama’s Affordable Care Act will have positive effects on hospital operators, as one of their main revenue sources have been from the reimbursement of Medicare and Medicaid.  The effort of this law is to provide health insurance for all US people and to reduce healthcare spending growth. It would expand Medicaid coverage for around 17 million people in the US, provide 47 million women access to preventative health services, and it also gives the seniors free preventative care and cheaper drugs. This law would improve the bottom lines of hospital operators including CYH, HCA Holdings (NYSE: HCA), Health Management Associates (NYSE: HMA) and LifePoint Hospitals (NASDAQ: LPNT). In 2011, the majority of CYH’s revenue source was from Managed Care and other third party payers, 51.5%, whereas Medicare and Medicaid accounted for 26.8% and 9.7% of the total operating revenue respectively. For HMA, Medicare accounted for 31% and Medicaid accounted for 9%. For HCA, the Medicare and Medicaid took around 34% and 10.5% of the total revenue respectively. LifePoint had a little higher percentage, 35%, from Medicare and 14.3% from Medicaid.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>CYH</strong></p> </td> <td> <p><strong>HCA</strong></p> </td> <td> <p><strong>HMA</strong></p> </td> <td> <p><strong>LPNT</strong></p> </td> </tr> <tr> <td> <p><strong>D/E</strong></p> </td> <td> <p>3.6</p> </td> <td> <p>Negative equity</p> </td> <td> <p>3.7</p> </td> <td> <p>0.8</p> </td> </tr> <tr> <td> <p><strong>Forward earnings</strong></p> </td> <td> <p>6.4</p> </td> <td> <p>7.7</p> </td> <td> <p>8.8</p> </td> <td> <p>9.7</p> </td> </tr> <tr> <td> <p><strong>Tangible book per share</strong></p> </td> <td> <p>-19.7</p> </td> <td> <p>-27.3</p> </td> <td> <p>-0.8</p> </td> <td> <p>6.3</p> </td> </tr> </tbody> </table>

It seems that all hospital operators employ high levels of debt. HCA even has negative equity due to high level of negative retained earnings. As of September, it had  negative equity of $7.86 billion, whereas the total long-term debt was more than $25 billion. LifePoint is the least leveraged, with only 0.8x D/E. It is also the only company that has a positive tangible book value.

Just two weeks ago, Glenview Capital, managed by Larry Robbins, reported to increase its holdings in CYH to nearly 7.65 million shares, or 8.39% of total company. Glenview Capital now effectively invested 30.5% of its funds into Health Care industry, out of 45 stocks it owns. The current biggest position is Life Technologies (NASDAQ: LIFE) with nearly 11.5 million shares. LIFE’s position is worth nearly $560 million, accounting for 9.2% of the total portfolio. LIFE is trading at $50.08 per share, with the total market capitalization of $8.62 billion. The market is valuing Larry Robbins’ biggest position at 12.3x forward earnings. In addition, he also owns 8.43 million shares of HCA, accounting for 4.6% of his portfolio.

My Foolish Take

The future seems to be bright for hospital operators with the Obama administration. However, I think investors need to dig deeper to find the suitable opportunities and some diversification. Personally, I prefer LifePoint for its most conservative capital structure. 

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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