- If the coronavirus situation becomes more serious and causes a large number of people in the US to get hospitalized, HCA as the largest American hospital company should benefit.
- If the epidemic passes quickly, overall stock valuations should go up.
- HCA’s shares have close to 30% upside to fair value.
- A large-scale change in government’s role in healthcare remains the biggest risk.
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Stocks cratered last week on the expectation that the coronavirus will spread, affecting business operations and consumer spending. Companies are canceling non-essential travel and people are reluctant to plan vacations, thus, it is understandable that firms that operate in the travel and leisure field are taking a hit. Supply chain disruptions may affect industrial firms and consumer sentiment may sour. On the other hand, companies like Zoom Video (ZM), Teladoc (TDOC) and Clorox (CLX) are expected to see increased sales, with their stocks rising. Was there a company that could benefit if the epidemic became a pandemic and whose stock hadn’t gone up? Surprisingly, I found one which had actually declined as much as the market had. I present HCA Healthcare (NYSE:HCA), the largest hospital company in America, with a small presence in the UK.
The thesis here is simple. If large numbers of people get sick and hospitalized, it is natural to expect a hospital company to benefit. If they don’t and the scare passes, then stock valuations go up and the stock does too. Heads, HCA wins; tails, the virus loses (and HCA still wins). I like the odds.
Nine months ago, I published an article saying that HCA belonged in a healthy portfolio. Over the next few months, the stock gained more than 20%, but has given up most of those gains, now trading at 11x EPS. I see 30% upside ahead.
HCA is expected to generate revenue of $54 billion this year, 6% more than last year, aided by a few tuck-in acquisitions. The company has consistently generated an operating margin of 14-15% over the last few years. The consensus expectation is for EPS of $11.71 this year, up 11% over the prior year, with the benefit of some shares being bought back. Note that the EPS numbers are clean figures, after stock compensation and the like that some companies exclude in pro-forma reporting.
HCA’s free cash flow is usually a little less than net income due to capex exceeding depreciation as the company invests for growth. The company deploys the cash generated in a balanced way towards acquisitions, a dividend of $0.43 per quarter (1.3% yield) and share buybacks.
The flu season this year has reportedly been worse than usual, which should benefit the company, but I believe the impact is in the projections already.
So why has the stock gone down?
HCA has a high debt load of $34 billion and a quarter of its operating income goes towards debt service. In a market downturn, the stocks of highly indebted companies usually go down more than the index because their profits would be disproportionately affected by a decline in revenues. The risk of bankruptcy also goes up. However, HCA has a steady business that is largely immune to the business cycle.
While any virus that infects people may be a positive for HCA, the Bernie virus is thought to be decidedly negative. For a detailed discussion of how Medicare for all may affect the company, please refer to my prior article. One theory is that Bernie Sanders coming closer to winning the Democratic nomination for President contributed to the market decline last week, not just the coronavirus news.
It is also possible that holders of the stock sought liquidity from any available source as the market declined precipitously. Mutual funds and ETFs become forced sellers when faced with redemptions.
Valuation: Fair value of $164 for the stock
To value the stock, I would place a slightly less than market multiple of 14x on the company’s expected EPS of $11.71 for 2020. This would result in a target price of $164. Thus, the stock presents almost 30% upside from the current $127 price.
In bear case number one, the company would face margin pressure due to the rising cost of labor and fall short on its earnings, getting to only $10 of EPS. Disappointed investors influenced by political rhetoric would assign a 10x multiple resulting in a stock price of $100 for a 20% downside.
In bear case number two, private insurers get marginalized in favor of government payors and payments go down. It is hard to model such a scenario as it is anyone’s guess where the payments will be set and what providers may go out of business as a result. There could be considerable downside in this case.
In bull case number one, people infected with the coronavirus would flood the company’s hospitals, giving a boost to its business. I do not think any holder of the stock would wish for this scenario. The company is limited by the capacity it has available in terms of beds and employees, and if this is a temporary situation, the increased income would not be sustained. Maybe the company generates 10% more in profits in this scenario and the same 14x multiple would result in a $180 target price.
In bull case number two, the nation does not feel the Bern and investors seeing at least four more years of smooth sailing decide to pay a 16x multiple on the company’s earnings, resulting in a stock price of $187.
Risks are considerable
As the 2020 Presidential election gets into full swing, I expect candidates to fall over themselves bashing the healthcare industry. Investors may assign some probability to these fulminations becoming policy.
The company could face margin pressure due to reimbursement rates not keeping pace with increased compensation needed to attract healthcare workers in a tight labor market. Due to the company’s high debt load, the operating leverage is quite high.
The company faces the threat of governmental action claiming the company overcharged or defrauded the government since it is a large supplier to Medicare and Medicaid.
As the company is an active acquirer, it could make an overpriced acquisition or buy a chain that underperforms.
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Analyst’s Disclosure: I am/we are long HCA. 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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