HCA Holdings operates 166 hospitals and 113 surgical centers across 20 states, but instead of focusing on its near-record $2.3 billion in free cash flow, investors are fixated on a challenge to the Affordable Care Act, which is headed to the U.S. Supreme Court next month.
At issue are the tax subsidies that an estimated 13 million Americans are expected to use to buy coverage on federally run health-care exchanges in 2016. The challenge questions the legitimacy of the subsidies in the 34 states that do not run their own exchanges. If the challenge is upheld, individuals in those states could lose their subsidies, forcing many to drop coverage.
The outcome of the case is frightening to many Americans—and potentially reassuring to Obamacare’s opponents. But the impact on HCA (ticker: HCA) if the challenge is upheld is not as scary as it seems. Based on company forecasts, just 6% to 7% of HCA’s 2015 earnings before interest, tax, depreciation, and amortization are expected to come from Obamacare, with about a quarter of that unrelated to the exchanges at issue in the case.
Those concerns have triggered a 5% decline in the stock this year, to $70, after a 54% run-up last year. The pullback discounts some of the fallout from the coming hearing, and gives HCA no credit for potential earnings catalysts. More bumps in the road may lie ahead, but HCA’s underlying business is strong and growing, even without Obamacare. The shares could rise to $86 as HCA’s core hospital business drives earnings growth and the company buys back shares. Earnings could also get a lift from further indication that states like Florida are moving closer to expanding Medicaid.
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Analysts expect Nashville, Tenn.–based HCA to earn $2.2 billion, or $4.95 a share, this year, up 17% over 2014, on a 6% rise in revenue, to $39 billion. HCA declined to make executives available to Barron’s, but on a conference call this month, they forecast 2015 Ebitda at $7.35 billion to $7.65 billion, below consensus estimates of $7.7 billion. Executives noted that increased investments in technology and human-resource systems will improve profitability over time, and offered what analysts described as a conservative view of the lift that Obamacare could bring.
Two-thirds of HCA’s expected 7% Ebitda growth is likely to come from its core hospital business, not including Obamacare. “The draw is really a combination of the investments they are making in their operations, with a nice additional kicker from the Affordable Care Act,” says Kuhn Tsai, an analyst at OrbiMed.
Overall, HCA’s hospital admissions in the fourth quarter rose 5%, the highest in years. And the company has been taking market share steadily, aided by its expansion of outpatient services and strengthening of the cardiac and orthopedic areas, which attract doctors as well as more-complex cases requiring more care. Its recent purchase of 24 urgent-care centers, which can refer patients to its hospitals, should also help.
At 7.5 times this year’s enterprise value to Ebitda, the shares sell for slightly below the 7.6 average of its peers. Some analysts also note that HCA’s admissions growth and profitability has been stronger than the industry. At eight to 8.5 times 2016 Ebitda estimates, shares could climb to $86 from the current $70 says UBS health-care analyst A.J. Rice, who sees several avenues for upside to HCA’s earnings forecast.
CO-FOUNDED IN 1968 by Thomas Frist Sr., a former Air Force surgeon, the company, formerly known as Hospital Corporation of America, has grown through acquisitions, pruning its network along the way. Today, it is one of the country’s largest hospital companies, with facilities in desirable markets, like Florida with its aging population, and cities like Houston and Denver where employment has been strong. HCA’s heft helps in negotiations with suppliers as well as insurers, contributing to free cash flow growing at a 10% average annual clip for the past five years.
HCA hasn’t always been a model for the industry. In the late 1990s, it was the target of a Medicare fraud investigation that ended in a record $1.7 billion fine. And earlier this decade, its billing practices were the target of a probe by the U.S. Justice Department, resulting in a $16.5 million settlement.
HCA has been taken private twice, most recently in 2006 through a $33 billion leveraged buyout. In 2011, it came public again, raising $3.8 billion. Since then, the company has taken advantage of low interest rates to refinance debt, saving about $800 million a year in interest, says Zach Miller, co-manager of the $215 million Aquila Three Peaks Opportunity Growth fund, which has used credit analysis in its stock-picking to beat 98% of its peers over the past three years. HCA has also reduced its share count by 18% over the past four years and recently announced plans for another $1 billion buyback that could boost earnings per share by 2%. With debt/Ebidta of four times, down from 4.8 times around its IPO, Miller says, HCA’s balance sheet could continue to help the stock.
THEN THERE’S OBAMACARE, which boosted HCA’s 2014 Ebitda by 4.5%. One of the biggest benefits was the decline in uninsured patients—a trend that should continue. Since hospitals’ infrastructure costs are relatively fixed, any reduction in the number of people who can’t pay helps profitability.
More such benefits could lie ahead. In the 2012 challenge to the health-care reform law, the Supreme Court allowed states to opt out of Medicaid expansion. But lately, many states, like Indiana, have expanded Medicaid, and analysts think others, like Florida, may rethink Medicaid expansion—albeit on their own terms.
The near-term wild card, of course, is King v. Burwell, the Supreme Court case; a ruling is expected in June. At issue is a clause in the ACA that specifically mandates that policies purchased on exchanges “established by the state” are eligible for subsidies. The debate is whether the clause also applies to federally run exchanges.
A ruling upholding the challenge would affect coverage for an estimated 13 million people next year, many of whom would drop coverage without assistance to pay for premiums. That could ripple through the system, boosting premiums for still others, and perhaps prompting more to drop coverage.
But many large shareholders don’t see havoc ahead, in part because politicians are unlikely to allow constituents’ health-care coverage to be upended and may scramble for alternatives if the challenge is upheld. A recent survey by Credit Suisse found that 62% of investors expected a favorable ruling; only 3% expected the ruling to derail the ACA.
The situation creates uncertainty, which is about as comfortable to investors as a hospital procedure. But assuming that even an unfavorable ruling creates a hiccup rather than a lasting hit to HCA’s business, the prognosis for the stock still looks healthy.
Date: February 21, 2015