HCA is a Wall Street favorite again
By Donald E. L. Johnson
Health Care Strategic Management, April. 2002, Vol. 20, No. 4
Copyright 2002 by The Business Word Inc.
HCA is “one of our favorite health care stocks,” gushes an analyst for Morningstar.com, a highly-regarded evaluator of stocks and mutual funds.
While many integrated health care delivery networks (IDNs) and hospitals are struggling to break even, HCA is growing its earnings. And it is anticipating increased net revenues as it raises the rates it charges managed care organizations (MCOs) and self-insured employers.
Raise rates, invest, cut costs The HCA lesson for not-for-profit IDNs that have strong market positions is that they too must continue to demand more money from insurers, invest in new capacity and reduce operating costs.
Morningstar.com’s assessment is relatively credible because the firm is independent of investment bankers, institutional investors and commission-hungry brokers-all of whom force analysts employed by Wall Street brokerage firms to be bullish or else.
Wall Street discounts fraud issues Wall Street and Morningstar’s report discount the importance of reports that HCA still may owe the government some $2 billion for the Medicare fraud that occurred in some HCA hospitals more than 10 years ago. Indeed, last month, a U.S. Court of Appeals overturned the convictions of two former HCA executives.
Medicare’s regulations are so vague, the court said, that they could be reasonally interpreted in several ways, including the way the two convicted HCA executives interpreted.
In any case, analysts say, even if HCA has to come up with another $2 billion in fines, it has the cash flow and access to capital to comply. Investors will treat the fine as a one-time expense, and everyone will forget it and get on with business.
Stock looks fully valued HCA’s stock is fairly richly valued, according to Morningstar. The stock trades at 22 times 2001 earnings and about 17 times estimated 2002 earnings, compared with a 28 price earnings ratio for the average company in the Standard & Poor’s index of 500 stocks. This PE ratio appears a bit rich because its long-term earnings growth rate is 15%. Stocks generally are considered fully priced when the PE ratio is about equal to the historical growth rate.
With the stock trading at about $42 per share, Morningstar.com said it was worth about $54 and recommended it as a good long-term investment.
Revenues rise first time in four years The company’s sales dropped three years in a row before increasing in 2001. It’s 2002 earnings are projected at $2.39, up from a five-year high of $1.95 per share in 2001. In 2000, HCA earned 39 cents a share, compared with $1.11 in 1999 and 50 cents in 1998.
Investors like 6% ROI and 21% ROE Yet, its 6% return on assets compares favorably with the 5% ROA for its industry and 6% for the S&P 500. Its 21% return on equity is much better than the industry’s 15.1% and outpaces the S&P 500’s 19.8% ROE.
HCA’s 5.9% net margin compares with 4.2% for the investor-owned hospital industry and 9.8% for the S&P 500 companies.
During the last 12 months, HCA generated $117,300 in sales for each employee. “HCA’s operations look as good as ever, as the company continues to wrestle pricing power from managed care providers,” Morningstar says, adding, “In the December quarter, this led to a 7% general increase in prices and a 9% increase in revenue per admission versus the year-ago period.”
Balanced Budget Act of ‘97 is helping HCA What excites Wall Street about HCA? Well, the fact that the Balanced Budget Act of 1997 cut Medicare and Medicaid payments to hospitals so much that a third of them are losing money helps HCA. This is because many hospitals cut services as Medicare payments shrank.
“With fewer hospitals able to meet the care needs of America’s aging population, hospitals like HCA, which can meet those needs, have more pricing power than ever,” according to Morningstar.
Some bullish analysts (aren’t they all?) think HCA will increase its prices more than the 4% to 6% it has guided analysts to expect. “In fact, management has already negotiated an 8% price increase from managed care providers for 90% of its contracts for 2002,” say Morningstar.com. The company is telling analysts it will grow revenues an average of 8% a year over the next five years. That’s not dot-com growth, but it apparently is appealling to investors in this market.
HCA dumps unprofitable hospitals Left unsaid is that many HCA hospitals serve fewer unprofitable Medicare and Medicaid beneficiaries than most unprofitable not-for-profit and county-owned hospitals do.
When it saw that it couldn’t make money on Medicare and Medicaid in some of its hospitals, HCA wisely sold them and focused on expanding its profitable hospitals.
Historically, HCA has gone on buying hospital sprees and then weeded out the weaker performers in its portfolio as market conditions and reimbursement rules changed.
This isn’t to say, of course, that HCA doesn’t own and operate urban hospitals. But it does so in markets where it is a dominate muti-unit provider. It has the market power needed to shift unpaid Medicare, Medicaid and uncompensated care costs to small employers and even to some larger employers.
HCA owns and operates approximately 200 hospitals and other health care facilities in 24 states, England and Switzerland.
HCA is increasing capital expenditures To take advantage of growing demand in its markets, HCA is increasing its capital expenditures to $1.6 billion in 2002 and $1.8 billion in 2003 from an average of $1.3 billion per year from 1998 through 2001, according to Morningstar.com. As a result of such expansion, HCA is expected to grow inpatient admissions about 3% a year, compared with about 2% for the hospital industry, according to Morningstar.com.
In addition to expanding capacity and winning moderate price increases from MCOs, HCA has been working to reduce operating costs, according to its 2000 annual report.
Key elements of HCA’s strategy are to standardize processes while decentralizing decision-making. In other words, the company is returning to its decentralized roots.
“Perhaps the best example of this is our shared services initiative, which we believe will set our hospitals apart from all others in the industry,” the 2000 annual report said. “This initiative will create company-wide supply improvement and distribution programs, consolidate back office functions such as billing and collections to regional revenue service centerws, and upgrade financial and human reource systems with new software.”
Big analyst following indicates bullishness One indication of the popularity of HCA’s stock is that 23 securities analysts follow the company. That is a relatively large following, and it reinforces the Street’s bullishness on the stock. Analysts generally follow stocks they like and ignore those they don’t.
On a scale of one to five, with one being a buy and five being a sell, HCA last month was rated one of the most attractive stocks. Analysts’ ratings for HCA averaged 1.3 on March 8, according to First Call. Of analysts providing ratings, 16 gave the stock a strong buy, seven a moderate buy and only one a hold.
However, as anyone who has been following the Enron, Global Crossing, fallen Internet stocks and other Wall Street embarassments knows, Wall Street’s credibility is hurting these days. So, just because investors like what HCA is doing doesn’t mean it’s on the right track. But anyone looking at its recent record and current efforts has to believe its future appears to be pretty bright.