Hospital Stocks Are A Value Trap

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Includes: AET, CNC, CYH, HCA, HUM, MOH, THC, UNH, WCG
by: Dana Blankenhorn

Summary

Hospital chains are cheap right now, but in the long run, they are a value trap.

There are too many acute-care beds, as more patients are shunted to outpatient facilities.

In the long run, most will be bought by insurers or clinic operators, one at a time.

The decision by federal judge Rosemary Collyer that Obamacare insurance subsidies are unconstitutional has sent hospital stocks plummeting.

In the short run, they are bargains. In the longer run, not so much, and not just because the Collyer decision was stayed and will not hold up on appeal.

Hospitals are like hotels or airlines, in that they have a fixed capacity, and they don't make money when that capacity isn't being used. But occupancy rates are declining as people with chronic conditions are treated in out-patient facilities, as patients face higher deductibles, and as hospitals themselves face lower reimbursements.

The two companies that took the biggest falls on the Collyer news, Community Health (NYSE:CYH) and Tenet Healthcare (NYSE:THC), are also those most likely to snap back quickly over the next few weeks. But these chains are also in the most long-term financial trouble. Tenet has not earned a profit since the first quarter of 2015. It carries $14.4 billion in debt on $23.7 billion in assets. Community results show almost no growth, with revenues for the most recent quarter at $4.999 billion against $4.911 billion a year ago. Its balance sheet is just as debt heavy: $16.9 billion in debt carried by $26.7 billion in assets.

All that may cause you to think that the largest hospital chain, Hospital Corp. of America (NYSE:HCA), is the right place to be. It's true that HCA remains profitable, with $694 million in net income, $1.69/share, on revenue of $10.36 billion for the March quarter. But the company is growing revenues at less than 10% per year, its debt-to-asset level is near 100% so it can't buy other chains, and its operating cash flows of nearly $5 billion/year are nearly all eaten up in investment and financing, and it pays no dividend.

The best outcome is for some of these hospitals to be taken out by insurers, or by clinic owners that need acute care facilities. Managed care companies like Centene (NYSE:CNC), WellCare (NYSE:WCG) and Molina Healthcare (NYSE:MOH) will eventually need to buy acute care facilities in order to scale their managed care platforms profitably. Once Humana (NYSE:HUM) finishes its merger with Aetna (NYSE:AET), it will be in a position to buy hospitals, with its market cap of $60 billion and its need to differentiate from larger rival UnitedHealth (NYSE:UNH), which is still stuck with the old fee-for-service model (That's why it is making big noise about withdrawing from Obamacare while it ramps up its Harken Health unit as a competitor in the space).

The new model for healthcare is to combine expense controls with assured payments. Kaiser Permanente and Intermountain Health, which own healthcare facilities, have a huge advantage in the Obamacare exchanges because they are able to control how much they spend.

The fee-for-service model is dying, the fee-per-patient model is rising, and big hospital chains are being squeezed by these trends. I expect them to sell themselves in pieces, rather than wholesale, over the next four years, and then sell out completely to those who can assure them the cash and patient flows needed to stay in business.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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