Health Management Associates

(HMA)

needs more than a rebound in patient volumes to soothe worried hospital investors.

The rural hospital operator must find a way to treat more patients who actually pay their bills. For the third quarter, the company posted a robust 2.3% increase in same-hospital admissions and an even stronger 7.2% jump in same-hospital surgeries. That growth in volume helped push net revenue up 14.3% to $934 million -- $10 million ahead of the consensus estimate -- although net income actually slipped 2.8% to $86.8 million. Excluding special items, the company's third-quarter earnings of 39 cents a share matched Wall Street forecasts.

Still, Fulcrum analyst Sheryl Skolnick is less than impressed.

"Volumes were stronger than expected but look to be driven by MUCH higher uninsured admits," wrote Skolnick, who has a neutral rating on HMA's stock. "Of the 2.3% increase in same-store admits, uninsured admits were 24% of that growth."

To be sure, HMA continues to find itself treating more and more nonpaying patients. Due to that trend, the company has adopted a more conservative reserve policy to cover bad debts from the uninsured. The company will now establish reserves for self-pay accounts when they are 120, rather than 150, days old.

As a result of this "enhancement," the company said that it increased its provision for doubtful accounts by $35.3 million in the latest quarter. That change fueled a 69% surge in the company's third-quarter provision for doubtful accounts.

Even so, Skolnick suspects that HMA has done too little to address an obvious problem. Moreover, she questions whether the company should be allowed to exclude the entire $35.3 million charge as an unusual item.

"This is not a one-time 'fluff' item," she insisted. "In our view, it is serious and shows that HMA has finally capitulated on the issue of the impact of rapidly rising and inescapable increases in uninsured revenues in its markets."

Excluding the company's newly increased reserves, HMA actually saw its third-quarter bad expense drop slightly from 7.6% to 7.5% of revenue. But charity care -- provided to patients who are never expected to pay -- continued to rocket. Charity write-offs totaled $147 million, up nearly 40% from a year ago, in the latest period.

All told, HMA said that the number of self-pay patients increased from 6.6% to 7% of total admissions over the past year. The company pointed to its presence in states like Florida and Texas, which attract large numbers of undocumented -- and, thus, uninsured -- workers, when explaining that growth.

Some see a company that could be losing ground.

HMA reported "an amazing surge in surgery volumes -- well beyond the hospital industry averages," says Peter Young, a business consultant at HealthCare Strategic Issues. "But the revenue benefit from such cases was offset by the increase in the number of self-pay/uninsured admissions and a resulting increase in bad debt. ... The evidence suggests that HMA's markets present a larger uninsured problem that is not likely to improve."

Investors clearly sensed trouble. They pushed shares of HMA down 2.5% to $24.18 Tuesday afternoon.

To be fair, however, some spotted areas of improvement.

Besides the solid jump in volumes, Merrill Lynch analyst A.J. Rice noted, HMA saw its same-hospital margins increase for the second quarter in a row. In addition, he said, the company reported a 21% surge in cash flow that continues yet another favorable trend.

Going forward, Rice says that HMA should face easier comparisons as a result of the hit caused by last year's busy hurricane season. Thus, he remains a big fan of the stock.

"Excellent share appreciation potential exists," wrote Rice, who has a buy recommendation and a $30 price target on the stock. And "given HMA's long-term track record of delivering superior results, we believe a premium to the company's anticipated intermediate-term growth rate is a reasonable objective."

But Skolnick tore some of those bullish arguments apart. For starters, she called HMA's same-store margin improvements "suspect" because, she believes, they "depend crucially" on provisions for bad debt that may not be properly allocated. She also questioned the company's decision to include special items -- particularly gains from an asset sale -- in its reported revenue and, ultimately, its operating cash flow.

"Unless HMA has changed its business model from hospital operator to real estate trading company, gains from sales of assets should not be included in revenue," Skolnick said. "It isn't operating, it isn't the company's business, and it isn't right in our view."

Others found themselves challenging HMA on Tuesday as well. For example, UBS analyst Kenneth Weakley -- who was already bearish on the stock -- came right out and asked the company how it expects to achieve its ambitious goals for the future. To reach its midteens growth rate, Weakley pointed out, either pricing needs to accelerate or costs must come down.

For the latest quarter, HMA posted just a slight increase in pricing as a result of the heavy drag created by charity write-offs for the poor. The company did manage to cut its labor expense but continues to see other costs -- especially those for big-ticket supplies like implants -- continue to tick higher.

For its part, HMA said it hopes to see its pricing return to more historical growth levels in the future. Meanwhile, the company said it has already targeted medical implants -- made by companies like

Smith & Nephew

(SNN) - Get Report

,

Stryker

(SYK) - Get Report

and

Johnson & Johnson's

(JNJ) - Get Report

DePuy -- as a "major focus" for upcoming cost controls.

Looking further ahead, CEO Joseph Vumbacco continues to see attractive opportunities for HMA in particular and the industry as a whole.

"We continue to believe that, in the long run, healthcare is a growth business," Vumbacco said.

Nevertheless, Skolnick raises serious doubts about the company's own performance.

"This is a company that has literally spent hundreds of millions of dollars of borrowed money to do acquisitions only to deliver flat earnings and to serve increasing numbers of non-paying patients," she wrote. "Therefore, in our view, HMA shares are absolutely, positively fully valued ...

and we cannot recommend new investments in these shares."