Hospitals Get Stuck With the Bill

HCA's warning last week shows that caring for uninsured patients continues to hit the bottom line.
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A host of complications now threatens this year's hospital-sector recovery.

Last week,

HCA

(HCA) - Get Report

raised concerns about the entire group when it revealed that two lingering problems -- weak patient volume and bad debt from the uninsured -- would hurt second-quarter results.

The news came right on top of a separate warning from

Manor Care

(HCR) - Get Report

, a skilled nursing provider that reported a surprising drop in the admission of Medicare patients who tend to come from hospitals. Yet another busy hurricane season could leave some Florida hospital operators -- particularly HCA,

Tenet Healthcare

(THC) - Get Report

and

Health Management Associates

(HMA)

-- feeling under the weather as well.

Indeed, JP Morgan analyst Andreas Dirnagl on Monday downgraded HMA from overweight to neutral due in part to worries about potential hurricane disruptions. He also cut his rating on Tenet from neutral to underweight on concerns that extend far beyond the weather. Specifically, he warns that ailing Tenet could take years, rather than quarters, to recover.

But Peter Young, a business consultant at HealthCare Strategic Issues, believes the entire sector faces more pain ahead. He specifically points to HCA's recent leap in uninsured admissions when offering a dark prognosis for the group.

"The picture that has been painted is one of increasing demographic demand," Young says. "But the problem is: Who's going to pay for it? Increasingly, that question has troublesome answers."

HCA, which set a 52-week high of $58.60 less than a month before its profit warning, slipped 34 cents to $49.61 on Monday. Meanwhile, HMA tumbled 44 cents to $25.06 on the JP Morgan downgrade. Tenet, stuck in a fairly narrow range in recent months, fell 8 cents to $12.02.

Dark Prognosis

UBS analyst Kenneth Weakley has remained cautious on the hospital sector for quite some time.

Perhaps best known for exposing Tenet's doomed pricing strategy three years ago -- shortly before the entire sector got hurt -- Weakley has consistently held back from joining those who see an industry on the mend. He recently pointed to HCA's second-quarter profit warning when justifying his stand.

"Relative to the so-called secular recovery in patient volume and bad debt," Weakley wrote last week, "in our view, the quarter was a major disappointment."

Notably, he pointed out, HCA weathered a drop in second-quarter inpatient admissions despite an easy year-over-year comparison. Moreover, he stressed, the company found itself providing even more uncompensated care than it did a year ago.

Young, for one, sees clear reason for concern.

"HCA revealing a 5% increase in uninsured admissions is very troublesome," Young says, "as the company has over the past 18 months been very verbose in discussing strategies to reduce their exposure to self-pay, uninsured (patients) -- including slides illustrating 'stability' that were used in Wall Street presentations."

Young offers a few potential reasons for the second-quarter setback. For one thing, he says, hospitals have been losing many insured patients to outpatient facilities. At the same time, he adds, hospitals seem to be treating more uninsured patients than they -- or even the government -- had previously thought possible.

Looking ahead, neither Young nor Weakley sees an immediate cure for this particular problem.

"We do not believe that the number of uninsured is likely to fall much despite the steady, if restrained, job creation statistics over the past year," Weakley says. "This does not imply that strategies to improve the collections of co-pays and other out-of-pocket payments will not prove incrementally successful, but instead points to why the pressure from the uninsured may in fact continue."

Secondary Complications

Somewhat coincidentally, Weakley was cautioning hospital investors about a potential second-quarter threat even before HCA issued its own warning.

Early last week, Weakley highlighted disappointing news from Manor Care as a possible reason for concern. Manor Care blamed a sudden drop in recent Medicare admissions for an expected second-quarter shortfall.

"Given that the vast majority of weekly admissions in HCR's nursing homes are derived from inpatient hospital discharges (due to Medicare regulations), one basic conclusion from the HCR falloff is that late-June Medicare inpatient hospital discharges were well below expectations," Weakley wrote. Still, "at this point, there is insufficient evidence to conclude firmly that Medicare admissions across the nation are slowing, in large part because none of the hospitals has yet to report or preannounce second-quarter earnings."

HCA issued its profit warning the day after Weakley's report.

Since then, Dirnagl has chimed in with some worries of his own. To be fair, he downgraded HMA primarily due to valuation concerns. But he cited threats related to Mother Nature as well.

"We have specific HMA concerns," he wrote, "as business-interruption insurance from last year's hurricanes runs out and as Florida braces for what appears to be possibly another strong hurricane season."

Young believes that companies like HMA, which count Florida as a major market, have already felt some pain. He points out that three early storms have already threatened the Florida region. Moreover, he adds, hospitals -- faced with taking necessary precautions -- can lose business whether the hurricanes hit or not.

Indeed, Young estimated earlier this month that some hospitals in the Florida region had already lost some valuable elective business as a result of recent storm threats.

"The hospitals make a big deal about February -- and if it is or is not a leap year -- and how one day impacts revenue," Young points out. "Well, it looks to me like hospital revenue in the 'cone' areas will be off four days already due to storm preparedness and associated canceling by hospitals of elective procedures."

Besides HMA, Young singles out other companies with "substantial" assets in Florida -- namely HCA and Tenet -- as likely weather victims.

Lengthy Recovery

But Tenet, at least, faces even bigger headaches.

Dirnagl listed several on Monday when steering investors away from the stock. For starters, he reminded, Tenet remains under the cloud of government investigations. Moreover, he noted, Tenet's past conduct has left the company with a "tarnished image" that could be hurting its relationships with physicians and private insurers as well.

In addition, he added, the company has been forced to spend plenty on labor -- due to staffing ratios in California -- at a time when its facilities could be using some of that cash instead.

"Notably, in '04 the company deployed just $538 million of the $600 million annual capital expenditure budget," Dirnagl wrote. "Cutting back on facility expansions and improvements, particularly during times of trouble, could further alienate physicians and potential patients in future quarters, resulting in continued depressed volumes."

For now, at least, Dirnagl sees little relief ahead.

"Despite positive steps achieved, Tenet faces several company-specific and industry-wide challenges," he explained. "Consequently, we believe that a recovery will occur, albeit in a somewhat longer time frame -- a few years rather than quarters -- than the Street apparently expects."