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Tenet Downgraded to Neutral

Zacks Equity Research

We have downgraded our recommendation on Tenet Healthcare Corp. (NYSE:THC - News) to Neutral from Outperform on its continuous high operating expenses, rising bad debt and expected rise in collectibles in the upcoming quarters. High leverage amid the poor global economic scenario is also keeping us on the sidelines.

Since 2006, Tenet has been steadily generating growth in operating revenues, mainly due to increases in the outpatient visits, improvements in managed care pricing and a favorable shift in managed care payer mix.

Last week, the company announced its adjusted earnings before interest, taxes, depreciation and amortization (:EBITDA) projection of $1.2–1.3 billion for 2012, which is substantially higher than 2011’s guidance. The uptick is based on an expected upside from cost reduction in 2012 through Tenet’s ongoing Medicare Performance Initiative, an increase in its physician count and growth projection in the company’s Conifer service business.

Moreover, Tenet has been steadily expanding its operating capacity via acquisitions. During the fourth quarter of 2011, the company completed the acquisition of CardioVascular Associates P.C. Additionally, Tenet acquired various diagnostic imaging centers in Georgia, Alabama, California, Florida, South Carolina and Tennessee in 2011.

Going ahead, the company also intends to acquire hospitals and other health care assets to increase the outpatient revenues, as historically, the outpatient business has generated significantly higher margins than other business lines.

However, on the downside, Tenet has been experiencing a high level of operating expenses in the past few years. The impact of industry-wide and company-specific challenges, including decreased volumes, decreased demand for inpatient cardiac procedures and high levels of bad debt, led to the rise of operating expenses.

Moreover, the high level of uncollectible accounts and rising bad debts impelled the company to increase its provision for doubtful debts substantially over the years. The company expects to continue recording higher uncollectible accounts in the upcoming quarters as well.

The Zacks Consensus Estimate for the fourth-quarter earnings is pegged at 14 cents per share, up about 39% over the year-ago quarter. For 2011, Tenet’s earnings are expected to be 42 cents per share, growing about 2% from 2010.

Tenet competes with HCA Inc. (NYSE:HCA - News) and Community Health Systems Inc. (NYSE:CYH - News). The company carries a Zacks #3 Rank, which implies a short-term Hold’ rating.

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