2023-12-14 11:53:50 ET
Summary
- HCA Healthcare's Q3 earnings resulted in an earnings miss due to a loss from a joint venture.
- Despite the setback, HCA's business drivers remain strong, with improved cost-to-charges ratio and increased patient volumes.
- I predict a double-digit upside for HCA, with a price target of $313 based on discounted cash flow analysis.
I am revisiting my Q2 thesis on HCA Healthcare, Inc. ( HCA ) in light of Q3 earnings.
Looking back on my Q2 analysis, I rated HCA a buy and felt that 10% upside was well within reach. Here was my thinking:
- Management's increased guidance, as well as 2024 implications, suggested continued outperformance.
- Cash flow would continue to cover shareholder returns and investment in growth.
- Multiple valuation methods suggested 10-20% upside
Since my Q2 analysis, HCA Healthcare has been largely flat, returning just over 1%, on the back of an earnings miss in Q3. Across the year, HCA has returned 8%, pacing well behind the broader market.
An unexpected loss from an emergency physician joint venture drove the earnings surprise. Despite the mixed results in Q3, I continue to rate HCA a buy. Business drivers continue to be strong, the joint venture is just a bump in the road (and HCA has overcome similar bumps), and valuation models suggest a double-digit upside is still likely.
Business Drivers Continue To Be Strong
Healthcare in 2023 is a challenging business as payers push to pay less and approve less, while inflation and physician shortages drive up the cost of care. As I have shared before, McKinsey believes that EBITDA in the healthcare industry will deteriorate between 90 and 250 basis points.
Digging into the core business, HCA is currently outpacing broader industry expectations. I think the most compelling statistic is the cost-to-charges ratio which compares patient care costs to gross patient revenue. Despite inflationary pressures, HCA improved this metric by 30 basis points year-over-year.
Patient volumes were also up across the business. Revenue per admission and admissions were up, both on a total basis and on a same-facility basis. While not broken out in the 10-Q, management further noted in the earnings call that volume was up across the service lines.
During the investor day presentation, HCA provided a breakout showing historic growth in revenue per equivalent admission, which has grown every year since 2012. This further speaks to the overall strength of the underlying business.
This is especially impressive considering that the overall industry has seen volumes and revenue decrease this year. Outpatient revenue dropped 8% across the industry while HCA delivered a steady 6% CAGR.
In addition to growth at existing facilities, HCA is working to expand the number of locations to be able to serve more of their customers' needs and keep them in the network. The growth plan is especially pronounced in outpatient services that can serve as a funnel to high-dollar hospital services.
A recent example of growth was the purchase of a bankrupt hospital near Dallas. HCA purchased Trinity Regional Hospital for $41 million at auction. Dallas is already a major market for HCA, so they can use their existing infrastructure and service centers to drive cost reductions and higher patient volumes from day 1. In my opinion, this is an excellent use of capital, especially at auction prices.
Joint Venture Just A Bump In The Road
The biggest impact from Q3 earnings was the announcement of a $100 million loss on the Valesco physician staffing joint venture. This drove an earnings miss as well as several downward estimates for the year.
Analysts expected HCA to increase earnings guidance, but ended up narrowing the range.
I firmly believe that this is just a short-term bump in the road. Nearly every question from analysts during the earnings call centered around the JV so I gained insights on the plan to address this. First and foremost, HCA has been here before. Coming out of the COVID years, HCA faced significant cost challenges from using contract nurses to cover shortages.
Within 1-year, HCA was able to turn the situation around by setting up training programs to increase the pipeline, while also improving billing and collections to get payers to pay out. HCA has also continued to manage cost per patient downward across their portfolio, as discussed above.
During the earnings call, management kept hitting the point that there was a payer issue compounding on a cost issue. And the business has plans to address both. With some companies, I would look at this as empty words, but HCA has repeatedly faced payer issues and cost issues without departing the 19-20% EBITDA margin range.
Having addressed similar issues in the past in under a year while protecting margin, I don't expect a long term impact to shareholders from the JV.
Double-Digit Upside Still Likely
In Q2, HCA was at $260 and my DCF suggested a price target of $315, 19% upside from today's pricing.
I updated the DCF for Q3 results with the following assumptions:
- Mid-point of management guidance
- HCA continues to outpace the overall industry by 1 percentage point
- Valesco impacts fades starting in FY25
With these assumptions, I generate a price target of $313 or 17% upside from today's pricing. Note that shares outstanding decreased partially offsetting the impact of lower guidance.
Wall Street analysts have come down since Q2, but still concur with the buy rating at a price target of $285, or 6% upside.
Downside Risk
The primary challenges that could potentially hinder HCA's growth trajectory are physician contracts and professional services. Valesco is one example of many where the no-surprises act has slowed down payments and reduced physician yields. If they don't solve for Valesco and the overall physician shortage driving up costs, there will be downward pressure on the price target.
Additionally, as I noted last time, a study published in the Journal of Healthcare Management highlighted the complexities around physician contracts, indicating how these changes could significantly impact healthcare organizations' financials.
Verdict
In summary, the Q3 results for HCA, following mid-point management guidance, show a potential 17% upside with a price target of $313 based on DCF. While I need to keep an eye on physician costs overall, the history of HCA management shows that Valesco is a short-term blip that will be solved aggressively. Underlying rate and volume drivers are materially outpacing the industry driving substantial cash flow. With all of this in mind, I continue to rate HCA a buy.
For further details see:
HCA Healthcare Continues To Impress