What would you think of a company which has a monopoly in a non-elastic market, great growth prospects and a price that implies pre-tax earnings yield of 34.12% and after-tax earnings yield of 23.76% (without pricing in growth)? If you think it might be an opportunity, keep reading, you may be on to something.
The company I'm talking about is Community Health Systems (CYH). This company provides healthcare services through self-owned or leased 131 hospitals in 29 states. For 60% of its hospitals there are no direct competitors. In addition, since it operates mainly in rural areas, it is unlikely for a competitor to move in and build a new hospital to compete with CYH since the market will not be able to sustain them both.
The management is aware of this fact, as shown in the latest annual report, and as a result the company works continuously to strengthen this advantage. It searches mainly for rural hospitals without direct competition, to buy, renovate and expand them. This strategy also provides the company two ways for growth:
- Keep on buying more and more hospitals.
- Reduce indirect competition. You see, in the 60% of the markets CYH operates (those markets without direct competitors), it has only 50% market share. The other half goes a long way to other hospitals (urban usually) that are bigger and more equipped to get specific treatment that CYH facilities don’t offer. This means that if CYH expands the services offers in its facilities, it can reduce indirect competition and gain more market share and revenue.
Both those two methods can keep the company growing profitably for years.
Currently, the company has revenue of approximately $150 per share. Operating and net profit margins are 3.9% and 2.7% respectively and they are getting better and better. The company has $1.75 of current assets for $1 of current liabilities which means no liquidity problems. The net asset value (NAV) is $26 and the earnings for 2011 are going to be 3.30 to 3.39 after tax according to management, and for 2012 around $3.60, after tax also.
With the price of the stock at about $16.5 we have an after tax earnings yield of 20% for 2011 and 21.18% for 2012, which makes for a current P/E ratio of 5 and a forward one of 4.58.
And while all these sound wonderful, every investor in his right mind would ask, "If everything about CYH is so nice why is it priced so cheaply? What's the catch?" Let's see what happened and why the company's stock was hammered from around $40 last April to just $16. All the trouble begun a year ago with an attempt from CYH to acquire Tenet Healthcare Corp. (THC). The whole deal turned ugly when THC rejected the bid and CYH tried unsuccessfully to change THC board. THC responded by suing CYH for overcharging Medicare, something that CYH dismissed and THC watered down after CYH withdraw its bid.
The only indisputable reason for worry about CYH is its great amount of long-term debt. The company as of its latest 10Q had $8.8 billions of debt outstanding. Half of this, $4.4 billions come due at 2014, $2.8 billions at 2015 and the rest later. In the case the company fails to refinance its debt at reasonable rates it may have to sell some of its hospitals. Now it's paying around 7.5% interest and if we assume pre-tax profitability at $350 million, the company can stand an interest rate up to 11%.
Even in the extreme event of a liquidation, stockholders have more than a good chance to be paid the company's net asset value which is $26 per share. The reasoning behind this claim is that the bulk of CYH assets (Hospitals) are unique pieces of real-estate with great positioning (since 60% of them are alone in their respective markets) and this will translate into very nice prices for those to be sold.
In conclusion, my case is that the market got over-spooked and is mispricing CYH for issues that do not exist or are not of such great concern. Admissions may fall a little but will come back because healthcare is one of the most basic needs people have. The company is most likely to refinance since it has a pretty stable business, more than enough profits and great assets as collateral for creditors. Finally the THC suit will most likely be dismissed and even if it's not I don't believe any substantial damage will be done.
I believe that below $18 this stock is a screaming buy and I would assume a fair value somewhere between $36 and $53.
Disclosure: I am long CYH.