Since the last time we checked on Community Health Systems (CYH), it had an amazing 76% rally from $17.05 to $30. Now, after an almost 11% correction to $26.79, I believe it's time to start rallying again.
Last year's earnings ($280 mln) were $3.15 per share while for 2012 EPS are expected around $3.5. To calculate EPS I used diluted shares outstanding as of June 30,2012. This is because the company is doing a lot of share buybacks. They have reduced the diluted shares outstanding from 108,378,131, at the end of 2002, to 89,281,868 at the end of Q2 2012. That's a 17.62% decrease. Not bad, don't you think?
Now let's talk about growth. On a y-o-y basis admissions are up 3% and Community Health Systems has also some great tailwinds for the years ahead. The biggest tailwind with the most immediate effect is Obamacare. Since everyone will be obliged to have health insurance one way or another, customer creditworthiness will increase along with the number of patients using CYH's hospitals. But even if Romney wins the election and cancels this piece of legislation, CYH still has two aces up its sleeve. The second tailwind and growth by acquisitions.
The second tailwind is population growth coupled with the increasing portion of people over 65 years of age. The following excerpts are from a 2008 research from the US Census Bureau: "... in 2030, when all of the baby boomers will be 65 and older, nearly one in five U.S. residents is expected to be 65 and older. This age group is projected to increase to 88.5 million in 2050, more than doubling the number in 2008 (38.7 million). ..." and "... The nation is projected to reach the 400 million population milestone in 2039. ...". What all this means is that in the long-term, CYH's hospitals will have more and more patients to care for.
CYH's management have proved their ability in choosing good hospitals as acquisition targets. This was made quite apparent when they organised and executed the merger with Triad Hospitals. With a single move they almost doubled CYH's size from 78 hospitals to 130. And they did it without compromising their moat. Triad was completely supplementary to CYH since both had similar business models: They ran hospitals in small and non-urban areas where their hospitals had a de facto local monopoly. And they got Triad essentially for free. That is because it's Triad's earnings that service the debt taken by CYH to buy it out. CYH in the meantime has increased the consolidated revenue by 50% and doubled the earnings for its shareholders, from $160 mln as of December 31, 2006 to approximately $310 mln expected for 2012.
However, the greatest source of concern is an accident with the repayment of the company's debt. CYH has almost $9.3 billions of long-term loans, as a result of the 2007 Triad acquisition. However, after refinancing part of its debt in February and issuing some notes in August, its debt maturity dates are more even distributed and as a result, more manageable. Additionally, according to the Q3 earnings press release all maturities are now distributed from 2017 to 2020.
Moreover, the debt to equity ratio is rapidly falling. CYH's debt level has fallen from 5.31 times equity after the acquisition in 2007, to 3.56 as of June 30 2012. This is because shareholder equity has doubled the last 5 years after the acquisition. This means that the company has a 5 year average return on equity (ROE) of 25%. Furthermore, it means that CYH grows rapidly and its debt levels will be in conservative territory (below 2 times equity) in a few years.
To sum things up, CYH is becoming more valuable for its shareholders every year. Given the 3.7% average, 5 year earnings growth rate and the favorable prospects Obamacare and population trends create, we can conclude that CYH has substantial growth potential. Finally, the stability that CYH's business has, plus the dominant position it enjoys (60% of its hospitals have a de facto monopoly), allow us to pay a higher multiple for the stock, due to great visibility.
All things considered, we can set a value range for the stock price somewhere between $45 to $60. Or to put it in P/E terms, between a P/E ratio of 13 and 17 (the industry's average). That is an upside potential of 67% to 120%.
Before you rush to call your broker though, some closing remarks:
- Always have a margin of safety. A purchase above a P/E ratio of 10 ($35) would not be advisable.
- For CYH to appreciate fully, time is needed. Nothing is going to happen tomorrow. Spend some time to think it through on your own.
- There will be bumps in the road, either the are a quarterly earnings miss, either a new US recession (there is this fiscal cliff thing hanging above us).
- Some other unspecified event.
Finally, do your own homework also. If you take only my word for it, you may lose conviction in the first pullback and get out of the stock when you should double down. So look the company up and if you have any questions feel free to post them below.
Disclosure: I am long CYH.