Hospital Operators: Room for Recovery
By Sam Stovall
Listed below are the sub-industries within the S&P Super 1500 that posted six-month (26-week) price performances that were in the top 10% of all 115 sub-industries through July 20, 2001. (Each sub-industry carries the highest S&P Relative Strength Ranking, or RSR, of "5.")
Last week, the Construction, Gold and Health Care Distributors industries dropped down to a six-month RSR of 4, replaced by Motorcycles, Paper Packaging and Water Utilities. The Health Care Facilities industry, which used to be called Hospital Management, is showing consistency across the board with an RSR of 5 during the past three, six and 12 months.
Rob Gold, S&P's Health Care Facilities analyst, is bullish on the group. Even though the hospital sector has suffered through periods of profit taking in 2001, Gold thinks the underlying fundamentals remain among the best in the overall healthcare sector. Gold would use weakness to take positions in the leading names in the group, as he believes valuations have become more reasonable. Positive operating trends include rising same-store admissions and net patient revenues, operating margin expansion, debt reductions and strategic acquisition strategies.
Hospital revenues and margins were significantly eroded by Medicare inpatient rate reductions enacted as part of the Balanced Budget Act (BBA) of 1997, which included a freeze to average Medicare rates in fiscal 1998 (Sept.) and only a 0.5% increase for fiscal 1999. Realizing that BBA lowered Medicare expenditures by nearly twice the original $115 billion projection, according to Congressional Budget Office estimates, Congress and the President have passed legislation, the Balanced Budget Refinement Act of 1999. That legislation should boost Medicare provider payments by about $18 billion through 2003, notes Gold. He adds that additional Medicare provider rate increases passed by Congress and the White House should boost hospital payments by about $12 billion over the five-year period ending 2004.
Regarding inpatient admission trends, the analyst believes that the return to more normalized 3% to 5% same-facility admissions growth is likely into 2001, following a 3% to 4% gain in 2000. Revenue growth prospects are further supported by the most favorable private pricing environment in recent memory, with rate hikes averaging 5% to 6% for most of the large hospital chains. Additionally, a renewed focus on collections is resulting in lower bad debt costs and improved cash flows, which can in turn be utilized to strengthen balance sheets, repurchase stock and/or make strategic acquisitions. The pipeline of attractive acquisition targets in the non-profit hospital market remains strong, and Gold looks for heightened deal-making activity during 2001.
Stovall is Senior Sector Strategist for Standard & Poor's