Initiating HMA at Neutral

Zacks

We initiate our coverage on Health Management Associates (NYSE:HMA - News), a leading operator of hospitals, with a Neutral rating. The company runs hospitals in select non-urban markets throughout the U.S., but mostly in the south eastern part of the country.

First-quarter 2011 earnings per share of 22 cents beat the Zacks Consensus Estimate by a penny. Health Management had total revenues of $1,434 million in the quarter, of which inpatient and outpatient services contributed about 50% each.  

Health Management continues to emphasize its three long-standing initiatives, namely Emergency Room (“ER”) operations, physician recruitment and market development, which have facilitated admissions. ER volumes, in particular, have picked up. As in the previous year, the company plans to recruit a substantial number of doctors. Health Management continues to expand its service lines by adding specialists in areas such as orthopedics, neurology, and cardiology. 

Delayed care continues to raise acuity in a weak economy. The company’s specialty recruitment and its market/service development are expected to drive acuity over the medium term as group hospitals become more adept at handling higher acuity patients.

We are relieved that bad debt is no longer an area of looming concern. Bad debt expense continued to moderate slightly at 12.1% of revenues in the first quarter, down 30 basis points year over year. We expect Health Management’s bad debt expense to be restrained in the rest of fiscal 2011 as well as 2012.

Health Management recently reached a definitive agreement to purchase the assets of Mercy Health Partners, a unit of Catholic Health Partners, of the East Tennessee health system based out of Knoxville. As a consequence, Health Management will take over, or lease, all 7 hospitals of Mercy Health Partners, with 1,323 licensed beds, and further continuum-of-care services. The purchase price is expected to be about $525 million, with adjustments.

The transaction is subject to review and regulatory approval, including the Vatican. The deal may be completed by October 1, 2011. Health Management has expressed a general keenness to acquire hospitals from a pipeline of good facilities.   

Commercial managed care continues to be the main source of pricing strength for Health Management. We expect the company to achieve commercial price increase of 5% to 7% in fiscal 2011. It is noteworthy that the company has already negotiated the majority of its contracts for fiscal 2012.  

On the negative side, we continue to have lingering doubts about sustained growth in volumes amid competitive pressures. A large part of the company’s strategy is contingent upon acquisition of acute care hospital assets and then improving their performance. Unexpected hurdles or delays in implementing operational improvements at acquired hospitals could result in margin deterioration. The lingering level of uninsured admissions remains another cause of concern.

We are also wary about Health Management’s high debt levels. However, the company derives certain free cash flow conferring it with sufficient debt servicing capability, for its category.  

Health Management’s competitors, in niche markets, include Community Health Systems (NYSE:CYH - News) and Lifepoint Hospitals (NasdaqGS:LPNT - News). Our long-term Neutral rating on Health Management is supported by a short-term Zacks #3 Rank.

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