Hospital Stocks Look Hale and Hearty
By Sam Stovall
Health-Care Facilities is a group that has been on Standard & Poor's list of industries with top for a while. It includes companies that own and operate for-profit hospitals and has been one of the better performing stock-market groups in 2002. Year to date through May 24, the S&P Health-Care Facilities Index was up 16.7%, vs. a 4.4% decrease for the S&P 1500 Super Composite Index (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) and an 8.3% drop for the S&P Health-Care Index, of which the Facilities group is a subset.
S&P analyst Phillip Seligman believes that valuations in the hospital group remain modest, in light of rapidly rising revenue and earnings forecasts throughout the sector. He cites a number of positive operating trends for hospitals: rising same-facility admissions and net patient revenues, increasing demand for health-care services from the baby-boom generation, improving operating margins, debt reductions, and strategic acquisitions.
Another factor working in the industry's favor, says Seligman, is the Balanced Budget Refinement Act of 1999. That's the legislation enacted after hospital revenues and margins were significantly eroded by Medicare inpatient rate reductions under the original Balanced Budget Act of 1997. The 1999 change should boost Medicare-provider payments by about $18 billion through 2003. And additional legislation signed into law in December, 2000, further increased rates, which should boost hospital payments by about $12 billion over the five-year period ending in 2004.
At the hospital level, inpatient-admission trends remain strong. Seligman believes that 3% to 5% same-facility admissions growth is likely in 2002, similar to the rate achieved in 2001. He says 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. Moreover, renewed focus on collections is leading to lower bad-debt costs and improved cash flows that can be used to strengthen balance sheets, repurchase stock, and make strategic acquisitions. And merger and acquisition activity will likely remain lively though 2002, notes Seligman, as a number of attractive acquisition opportunities exist in the non-profit hospital market.
Seligman's current favorites in the hospitals group are industry leader Tenet Healthcare (THC ) and two smaller players, Triad Hospitals (TRI ) and LifePoint Hospitals (LPI ).
S&P Relative Strength Rankings
These industries carry 12-month relative strength rankings of "5" as of May 24, 2002 -- meaning that they're in the top 10% of the 114 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior 12-month price performance.
*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).
Stovall is chief sector strategist for Standard & Poor's