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Hospital Industry Outlook: High Cost, Shift of Care Pose Concerns

Zacks Equity Research

The Zacks Medical-Hospital industry comprises for-profit hospital companies that provide healthcare facilities through different types of hospitals such as acute care, rehabilitation and psychiatric.

These hospitals are engaged in internal medicine, general surgery, cardiology, oncology, neurosurgery, orthopedics and obstetrics, mental health care, diagnostic and emergency services among others.

Hospital companies receive payments for patient services from the federal government under the Medicare program, state governments under their respective Medicaid or similar programs, managed care plans (including plans offered through the American Health Benefit Exchanges), private insurers and directly from patients.

Let us take a look at the industry’s three major themes:

•    A growing baby boomer population, rising prevalence of chronic diseases, increase in penetration of health insurance and low unemployment should continue driving demand for the hospital industry services. A research by IBISWorld shows that the industry has grown annually by 3.5% during 2013-2018, with $1 trillion of total revenues expected in 2018. This growth is expected to continue in the coming years on a surge in healthcare spending.

•    The industry is witnessing increased investments in health technology and concerted efforts to harness the power of big data in testing methodologies, discovering trends and providing information to support physicians and clinicians in enhancing quality of care. This should ultimately lead to lower costs and higher patient admissions, thus aiding both revenues and margins. Over the past few years, the industry has also started consolidating mainly due to the pressures of healthcare reform. Players are continuing to resort to mergers and acquisitions in order to create operational, strategic and financial value for their operations. Numerous deals have lead to economies of scale, helping the industry to efficiently manage costs and improve productivity and outcomes through higher business volumes, and enhance bargaining power with payers.

•    However, the industry continues to face shortage of labor specially relating to nurses. A decline in the number of nurses has led to an increase in hospital readmissions and stretches the length of stay, which has a negative impact on companies. In order to better face the nursing shortage, which is expected to persist through 2025 (according to the Bureau of Labor Statistics), companies are designing their employee benefits to attract and retain nurses. Despite efforts to retain and expand its nursing staff, players will feel financial pain, as turnover among nurses remains high and there are not enough new nurses entering the workforce. It should be noted that salaries and benefits constitute nearly 50% of the total operating expense for the industry. Also, growing efforts to reduce unnecessary hospitalization, greater use of chronic disease management programs and a shift toward outpatient treatment are partial dampeners to the industry’s growth.

Zacks Industry Rank Indicates Dull Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates sluggish near-term prospects. The Zacks Medical-Hospital industry, which is housed within the broader Zacks  Medical sector, currently carries a Zacks Industry Rank #213, which places it in the bottom 18% of more than 250 Zacks industries.

Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since October 2018, the industry’s earnings estimate for the current year has gone down by approximately 1.5%.

Despite the industry’s gloomy near-term view, we will present a few hospital stocks that one can hold on to. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Beats on Stock Market Performance

The Zacks Medical-Hospital industry has outperformed the broader Zacks Medical sector as well as the Zacks S&P 500 composite over the past year.

Over this period, the industry has gained 22% versus the broader sector’s decline of 6.4% and the S&P 500’s decline of 5.1%.

One-Year Price Performance

 

Industry’s Current Valuation

On the basis of forward 12-month EV to EBITDA ratio, which is commonly used for valuing hospital stocks, the industry trades at 7X versus the S&P 500’s 10.4X and the sector’s 9.5X.

Over the past five years, the industry has traded as high as 8.4X, as low as 6.5X and at the median of 7.2X, as the chart below shows.

EV/EBITDA Ratio (F12M)

EV/EBITDA Ratio (F12M)

 

Bottom Line

Focus on expanding footprint and product portfolio through acquisitions, along with cost-saving initiatives, are expected to drive the industry’s growth. The efforts on the part of hospital companies to expand its healthcare network that provide convenience and choice to its patients, should drive admissions. Investments in technology will increase the efficiency of operations thus leading to superior care at lower costs, which should benefit all sections of the industry.

However, rising labor costs from shortage of nurses and skilled workforce have weighed on the industry’s labor expense and will continue to do so.
None of the stocks in the Zacks Medical-Hospital space currently sports a Zacks Rank #1 (Strong Buy). So, here we present four stocks with a Zacks Rank #3 (Hold) that investors may want to hold on to for the time being.

You can see the complete list of today’s Zacks #1 Rank stocks here.

HCA Healthcare, Inc. (HCA): This, Nashville, TN-based hospital operates a network of acute care hospitals, outpatient facilities, clinics and other patient care delivery settings. The Zacks Consensus Estimate for 2018 and 2019 EPS indicates year-over-year growth of 41.7% and 8.3% respectively.

 

Universal Health Services, Inc. (UHS): This King of Prussia, PA-based hospital company operates behavioral health facilities, acute care hospitals and ambulatory centers throughout the United States, the United Kingdom and Puerto Rico. The consensus estimate for 2018 and 2019 earnings indicates year-over-year growth of 25.8% and 6.03%, respectively.

 

Community Health Systems, Inc. (CYH): This Franklin, TN-based hospital is a leading operator of general acute care hospitals in communities across the country. The company, through its subsidiaries, owns, leases/operates the affiliated hospitals in the states with an aggregate of licensed beds. The company reported better-than-expected EPS in three of the past four quarters, with the average being 53.5%.

 

Tenet Healthcare Corp. (THC): This Dallas, TX-based company provides technology-enabled performance improvement and health management solutions to hospitals, health systems, integrated delivery networks, physician groups, self-insured organizations and health plans.

The consensus estimate for 2018 and 2019 earnings indicates year-over-year growth of 98.8% and 12%, respectively.


 

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