Supply Down, Demand Up Means Higher Costs For Healthcare

Includes: CGHC, CYH, HCA, HMA
by: Charles Russo

An old friend from high school called me out of the blue last week to tell me that his wife was finally pregnant with their first child. We've known each other since we were 12 and we've kept in touch all these years, so this was pretty exciting. But before I even had time to jump up and down and celebrate he said, "Wait, there's a story behind it."

So I sat down, bracing myself and this is what he told me. Apparently, his wife, soon after taking a pregnancy test, started feeling severe abdominal pains. After two days, they would not go away and they finally decided to go to the ER. This is in Manhattan. There was some bureaucratic mess up involving her maiden name, under which she was registered with her insurance provider, but she had registered in the ER under her married name. The confusion resulted in her waiting for hours in the ER in severe pain while the ER staff figured out what to do. As long as you're conscious and not showing any clear outward signs if imminent death, they make you wait I guess.

Finally, hours later when they had this sorted out, they took a blood count, followed by another one a few minutes later, and found that her blood count was rapidly decreasing. They went in for emergency surgery after she was only a few weeks pregnant and discovered an ovarian cyst that was causing rapid internal bleeding. The wound was quickly cauterized and she was fine after that. 3 months later, when my friend called me, she was still pregnant.

Severe shortage in emergency health services

Google maps shows just nine facilities equipped with emergency rooms on Manhattan Island. This is supposed to adequately serve a population of over 2 million people, which typically doubles during business hours. These numbers belie what's going on nationally, with hospital emergency rooms declining by over 27% from 1990 to 2009. Unless America is getting healthier and less accident prone, I doubt this is a good statistic. If anyone is looking for the answer as to why medical care is becoming more expensive, there is no reason to look farther than simple supply and demand, as is the case with the cost of absolutely everything on Planet Earth. If the supply of medical care goes down because ER's shut down and the demand for medical care goes up because more people exist, the price of medical care will go up. It will go way up.

How do we fix this? The simple answer is, up the supply. Decentralize. We need more emergency care centers that are more specialized and cheaper to build and staff, so instead of everybody with severe stomach pains like my friend's wife limping over to the ER, only people who are clearly within minutes of dying should go there, while others should be sorted at other, more decentralized, cheaper, and more streamlined urgent care centers. At an urgent care center, a blood test could be quickly taken, and if emergency surgery cannot be done there, then she would have been sent in an ambulance to an ER with a recommendation for emergency surgery, instead of waiting for hours in the ER itself before they even take a blood test to figure out that she even needed it in the first place.

I'll get to urgent care centers in a minute, but the most crucial thing to know with regard to companies that own the healthcare infrastructure, being hospitals, is that in general, like any stock or commodity, as long as the demand for emergency care goes up while the supply of emergency care goes down, the price of emergency care will go up, along with the profits of the companies that supply it. Speaking of the demand for emergency care, I did not read the Affordable Healthcare Act nor do I intend to, but what I do know is that the legislation will dramatically lift the demand for emergency care under the protective wings of government mandated insurance, while at the same time discouraging supply even further by adding layers of bureaucracy to our healthcare infrastructure. I don't care what the government claims. This just means higher cost, which means more boom times for the healthcare sector, the one that owns the supply.

Here are two mid cap hospital stocks worth considering, one to avoid and one microcap worth keeping an eye on, in my view. The first, Community Health Systems (CYH), owns 131 hospitals throughout the country. After a brief pullback which should follow this stock's one and a half month 42% parabolic rise to all-time highs followed by a two to three month consolidation, I see this company clear to push a P/E ratio of 20, minimally. It is currently at 16. The reason is that its revenues keep rising, 16% since 2009 (before Obamacare passed), though its net income surprisingly sunk this year below that of 2009. Community Health clearly shows the ability to bring in revenue but suffers slight management and cost inefficiencies, which means that if and when it overcomes these, the stock will rise. With Obamacare kicking in on 2014, I see investors fronting its growth in 2013. The only serious issue with Community Health Systems is long term debt, which hovers over 2.5x its market cap. Caution is advised.

Next is Health Management Associates (HMA). HMA owns 66 hospitals around the country. This stock fell off a cliff back in 2007 for quite a strange reason. On March 2, 2007, HMA decided to play Joker in the original 1989 Batman movie and throw cash in the streets to its investors. On March 2 of that year, HMA unloaded a massive $10 per share special dividend to its shareholders that consisted of nearly $2.5B, totaling nearly half its entire market cap and over 13x its earnings that year. This led to an automatic $10 devaluation in its stock price. Since then, HMA has gone nowhere, but with revenues up 28% and income up 29% to match since 2009, in addition to the demand rush and supply crunch that will come with Obamacare implementation, we'll see this stock rise consistently through at least 2015. Long-term debt is also quite high relative to market cap, but not as high as the other companies mentioned here.

One to avoid (I wouldn't short it because it's impossible to tell what Obamacare will do to this sector as a whole, even for the bad stocks) is HCA Holdings (HCA). On the surface, HCA looks great. With 163 hospitals under its wing, revenues up 11% at nearly $30B last year and set to beat that this year. The problem with this company, as I see it, is twofold. One, it paid an exorbitant $8.5 a share in dividends last year, totaling $8.75B in giveaways to shareholders. Sound familiar? Half its market cap, 150% of its FY 2011 net income. Two, the company went into further debt to pull off this stunt. It's a honey trap. If you owned HCA before these dividends kicked in, good for you. But HCA has, no joke, $27B in long and short term debt on its balance sheet, and deepening that debt to grease shareholders with exorbitant payoffs just doesn't seem like the smartest move at present. Watch out for a rise in interest rates, which could fleece this company fairly rapidly. One could argue that CYH is in the same boat, but at least they're not "taking advantage of low interest rates" to further attract buyers by going even deeper into debt than they already are.

Are urgent care centers the solution?

Let me end off by going back to my high school friend. Manhattan, along with the rest of the country, needs a more streamlined, decentralized emergency care infrastructure. The fact that his wife had to wait for hours for a simple blood test while she was bleeding internally is mind boggling. One company you need to keep an eye on is Capital Group Holdings (CGHC.PK). It's a tiny microcap of $4.15M with revenues only starting last quarter at over $500,000. The company operates a total of seven urgent care clinics, which are like mini emergency rooms, in the Phoenix metropolitan area, an approach I see as the solution to alleviating the emergency care supply crunch, and something that will help absorb the demand explosion sure to come in 2014 as the individual mandate takes hold. Maybe CGHC will fail as many microcaps do, but the decentralization approach to emergency medicine is the key to whoever succeeds in doing it, so watch for other urgent care companies down the pike. One encouraging thing about CGHC, despite its obviously speculative nature, is that unlike its huge competitors, current debt on its balance sheet is only 13.5% of market cap. Let's see how this stock does when Obamacare kicks in.

It is clear that many of the patients in our ERs do not have to be there and can go to a lower cost effective urgent care center instead, and even if they do need to eventually go to the ER, simple things like blood tests that can be conducted quickly in these small centers can be used to sort out the real emergencies from the less pressing cases and save lives.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.