'Even without an IPO, we'd own HCA'

Analyst likes debt of hospital giant and other locals, chides CHS for not lowering costs

Email | Print By Geert De Lombaerde

10-27-2009 3:08 PM — Pali Research analyst Sheryl Skolnick has launched coverage of a number of Nashville’s biggest hospital companies, saying investors will do well by buying their debt while being neutral on the prospects of Community Health Systems shares.

Skolnick, who last week called out the management team at LifePoint Hospitals, said HCA, Vanguard Health Systems and Iasis Healthcare have done a good job managing their costs in 2009 and are positioned to grow margins going forward. CHS, on the other hand, missed the boat earlier this year when it had the chance to meaningfully cut costs.

Here’s a more detailed rundown of her thoughts on the four locally based companies, which have combined annual revenues of more than $45 billion.

HCA – Skolnick came right out and answers the question most HCA watchers are focused on these days, saying she expects the company to file for an initial public offering when lawmakers pass a health reform package. But, she added, the hospital titan’s “prudent” capital spending, cost cuts and physician recruitment strategies means she “wouldn’t quibble with any hold of debt” issued by the company.

“Even in weak cash flow years, the company still can generate nearly $2 billion in cash flow from operations, put $1.2 billion to work in maintaining and growing its hospital base and that’s after paying nearly $2 billion in interest expense,” Skolnick wrote.

Still, she isn’t forecasting any bottom-line growth next year and sees revenues rising less than 4 percent to $31.0 billion. Among the dark clouds on HCA’s horizon is its bad debt level, which she expects to rise to almost 12 percent of revenues if, as is expected, the economy struggles to create jobs in coming quarters.

Community Health Systems – Skolnick takes CEO Wayne Smith to task for not cutting costs earlier this year. That, she said, could come back to bite the company.

“Should recovery be elusive or recession return with a vengeance, CYH will be behind the ‘eight ball’ relative to those hospital operators like Tenet and HCA that did, and have reported materially better margins, without backlash from employees or vendors,” she wrote.

Along the same lines, Skolnick “would be pleased to see CYH take steps to reduce its leverage,” which has been among the highest in the industry since its 2007 acquisition of Triad Hospitals. And, while noting the company’s excellence in digesting acquisitions, she said she would by now have expected its margins to grow as new hospitals are brought up to speed.

The coming year could be “much more difficult” for earnings, Skolnick said. She is forecasting per-share growth of about 10 percent, half of the 2009 pace.

Vanguard Health Systems – In launching coverage of the company’s high-yield debt with a ‘buy’ rating. Skolnick said its Medicaid HMO stands to benefit from “any contemplated expansion of coverage,” which will give its operations in Chicago and Arizona a boost.

More generally, Skolnick said Vanguard’s cost controls will help its grow margins in fiscal 2010, when she expects net income to rise to $46.5 million from $26.8 million this year. Rising cash flows should in turn help CEO Charlie Martin and his team replace their revolving loan next fall and their term loan in late 2011.

“Between the cost cuts, relative stability in overall volumes and improvements in managed care pricings, the hospitals are generating year-on-year earnings improvement before one-time items,” Skolnick wrote, adding that, given its upcoming debt deadlines, the company’s “improving operating metrics couldn’t come at a better time.”

Iasis Healthcare – As with Vanguard, Skolnick cites Iasis’ Medicaid HMO operations in Arizona as a possible growth kicker. The Franklin-based company, she said, should greatly improve its 2010 cash flow from operations while net income is expected to grow by more than a quarter to $90.8 million.

“We like the cost discipline, the capacity additions and the prospects for continued margin improvement,” she wrote.

Looking a bit further out, Skolnick said she is watching for the company to launch some sort of refinancing transaction soon. More than $1.4 billion will mature in 2014.