Are Labor Costs Really A Problem For Healthcare Services Sector?

|
Includes: CURE, CYH, FHLC, FXH, HCA, HQH, IHF, IYH, RXD, RXL, RYH, THQ, VHT, XHS, XLV
by: Obsidian Research Group

Summary

Labor Costs were a drag on earnings in late 2015 for hospitals.

Data reveals that the pressures are confined to General Medical and Surgical Hospitals.

We expect the pressure to subside in 2016.

Labor Costs: Are They Really a Problem for the Health Care Sector?

ABSTRACT:On several Q3'15 earnings calls, several publicly tradedhealth care services companies disclosed higher than expected labor costs. In advance of Q4'15 earnings releases, we looked a little more closely at the labor costs and hours worked at general medical and surgical hospitals and compared those observations with the ambulatory healthcare sector. Indeed labor costs and hours worked at general medical and surgical hospitals have been increasing at an accelerated rate relative to the consumer price index for health care services. However, average hourly wages for all ambulatory services such as physicians' office, outpatient centers and home health have stayed below general medical services inflation. We do not deny the demographic realities that fewer working age people will be available to care for the elderly in the coming decade, we just do not think that is what is going on today. The increased labor costs reported by HCA Holdings (NYSE:HCA) and Community Health Systems (NYSE:CYH) appear to be a phenomenon largely confined to inpatient hospitals. We think it is worth monitoring the Bureau of Labor Statistics releases each month to detect any changes in the current trend.

BACKGROUND: The Q3'15 earnings releases were filled with concerns about increased labor costs, particularly for hospitals. Bill Rutherford, the CFO of HCA cited increased costs for contract labor and productivity declines:

There are primarily two items that impacted our labor cost. We saw an increase in the use of contract labor during the quarter. Our contract labor expense was up $55 million or 36% as compared to the third quarter of 2014. We have seen growth throughout the year but it did accelerate during this quarter. This increased use of contract labor is used to fill in for staff vacancies that occur because of higher turnover rates and needs we have to serve the increased volume.

Because of the premium we have to pay for these contract labor resources, we estimate this issue had about a $25 million impact on the company's year-over-year performance. The other labor observation I will call out is some productivity declines we experienced in the quarter. In essence we didn't achieve the operating leverage we had anticipated from the volume growth. We did see this developing in the quarter and our management teams have already begun necessary adjustments. We estimate this issue had about $25 million impact on the company's performance for the quarter

Larry Cash, the CFO at CYH echoed these sentiments:

Our salaries and benefits as a percentage of net operating revenue increased 40 basis points, as a percentage of revenue to 46.2%. Our increase as a percentage of revenue is due to the higher costs associated with employed physicians and our lower shift in our payer mix. Our productivity declined 100 basis points in the third quarter compared to the first six months. Our number of employed physicians increased the most in the Florida markets. Salaries and benefits in physician practice increased about $25 million. In the prior year, it only increased about half that amount.

Tenent Healthcare (NYSE:THC), while acknowledging earlier struggles of their own with labor costs, reported that the problem was under control during Q3'15. Lifepoint Health (NASDAQ:LPNT), which operates largely in rural markets, went against trend and announced improvements in labor costs. Other provder types like Kindred Healthcare (NYSE:KND) reported tightening labor markets in some of their regions but with limited financial impact. Home Health Agencies such as LHC Group (NASDAQ:LHCG) reported that their contract labor costs had actually declined.

The company specific evidence appears mixed but it is still worth asking if labor costs an emerging problem for health care services.

ANALYSIS:For three of the last five years, labor costs for general medical and surgical hospitals like those operated by HCA, CYH, THC and LPNT, have closely tracked overall inflation for health care as measured by the Consumer Price Index for all Urban Consumers (CPI-U) for health care services, a subset of the economy wide Consumer Price Index. Chart 1 illustrates the last five years of CPI-U for health care services compared to average hourly wages for all employees of general medical and surgical hospitals.

Chart 1 - CPI-U for Health Care Services vs. Average Hourly Wages for All Employees of General Medical and Surgical Hospitals

Click to enlarge

Source: Bureau of Labor Statistics

Beginning in May of this year, the lines diverged and labor costs began outpacing general inflation for health care services, catching some hospital executives a little off guard.

Consistent with the increase in hourly wages is the uptick in hours worked beginning with the expansion of health insurance coverage under the Affordable Care Act in 2014. Up until Q1 2014, average hours worked at general medical and surgical hospitals operated in a relatively tight band around 36 hours per week. Around May 2014, the average number of hours worked began a steep climb toward 37 hours per week and in November 2015 made a turn back toward the norm. If the November trend persists, hospitals should now be seeing some relief in labor cost pressures. Chart 2 on the following page illustrates the average number of hours worked at general medical and surgical hospitals since January 2010.

Chart 2 - Average Hours Worked Per Week at General Medical and Surgical Hospitals

Click to enlarge

Source: Bureau of Labor Statistics

Interestingly, the wage pressures seem more or less confined to the inpatient hospitals. Wages associated with ambulatory services, such as physicians' offices, outpatient care centers and home health have underperformed relative to general inflation in the health care services sector. Given the dramatic shift from inpatient care to outpatient, one would expect a different result. The absence of a trend similar to that at general medical and surgical hospitals suggests the problem may be limited at this point. Chart 3 on the following page compares CPI-U for health care services to average hourly wages for all employees of ambulatory services providers over the last five years.

Chart 3 - CPI-U for Health Care Services vs. Average Hourly Wages for All Employees of Ambulatory Services Providers

Click to enlarge

Source: Bureau of Labor Statistics

Not surprisingly, hours worked in the ambulatory services area have remained flat over the last five years. Chart 4 on the following page illustrates the change in average hours worked in ambulatory services over last five years

Chart 4 - Average Hours Worked Per Week at Ambulatory Services Providers

Click to enlarge

Source: Bureau of Labor Statistics

CONCLUSION: While we acknowledge that demographics could threaten the cost structure in the health care sector in the coming years, the current labor cost pressures being felt by inpatient hospitals are probably transitory and likely to correct with proper managerial intervention. If and when we see similar wage pressure across the acute and post-acute sectors, we may reassess that conclusion.

Disclosure: I/we 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.