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Psyched Out at Universal Health Services

The hospital chain's repeated shortfalls worry some.

Universal Health

(UHS) - Get Universal Health Services, Inc. Class B Report

has missed again.

The King of Prussia, Pa., hospital operator warned late Monday of a big fourth-quarter shortfall and issued disappointing 2006 guidance, due in part to lost business from hurricane-damaged hospitals and rising bad debts from the uninsured. Excluding special items, the company is now forecasting a fourth-quarter profit of between 43 cents and 45 cents a share. Analysts were looking for 56 cents instead.

Universal has now failed to meet Wall Street expectations four out of the last five quarters. Moreover, even the company's strong behavioral health division lost some of its shine this time around. The company specifically noted that its new Keystone and Brown behavioral schools pressured results in the latest period.

Prudential analyst David Shove sounds worried.

"Since Universal Health Services' behavioral health operations are supporting its current valuation, Key and Brown School acquisitions' dilutive effect raises concerns over future acquisition activity," writes Shove, who has an underweight rating on the company's stock. "If future behavioral asset acquisitions are not readily accretive, Universal Health Services' earnings power could suffer new erosion pressures."

Universal is already forecasting slower profit growth than many people had expected. The company now believes it will generate 2006 operating profits of between $2.70 and $2.75 a share. Analysts, on average, were forecasting 2006 profits of $2.89 a share ahead the company's update.

Universal's stock initially took a big hit, falling more than 5% in premarket trading on Tuesday. However, it soon regained most of that ground -- slipping less than 1% to $47.35 -- during the regular session.

Mixed Vital Signs

Universal's projected fourth-quarter revenue of $967 million fell short of the consensus estimate. Yet outside the hurricane-ravaged Gulf Coast -- where several Universal hospitals have shut down -- the company actually enjoyed a solid pickup in business.

Excluding its hurricane-damaged facilities, Universal saw acute-care admissions rise 3.4% during the latest quarter. Behavioral admissions bounced an even-stronger 7.4%.

But some worried that those gains, particularly in the acute-care business, came at a price. They voiced some concern about the behavioral health business as well.

TheStreet Recommends

"Despite solid same-facility acute-care inpatient admissions, the underlying EPS and revenue results would seem to indicate an unfavorable mix of admissions, with high levels of uninsured likely," notes Credit Suisse First Boston analyst Glen Santangelo, who has a neutral rating on the company's stock. "To date, we believe investors have been willing to afford UHS a higher multiple than its peers primarily because of its psych business. However, at a first glance, the psych results appear to be just in-line with expectations, which may dampen some investor enthusiasm."

Santangelo has already lowered his own expectations for the company for both this year and next.

To be fair, however, some experts have expressed optimism about Universal's future. Jefferies analyst Frank Morgan even took the company's disappointing update in stride. Indeed, Morgan said the company's 2006 outlook essentially matches his own. He personally expects the company to kick off the year with another tough quarter -- when it faces difficult year-over-year comparisons -- but then show "marked improvement" as the year goes on.

Morgan has a buy recommendation on Universal's stock. His firm has performed non-investment banking business for the company over the past 12 months.

Meanwhile, Wachovia analyst William Bonello seems increasingly upbeat about the company's future as well. Bonello was reluctant to recommend the stock ahead of an expected fourth-quarter miss. However, he has signaled that an upgrade could be on the way.

"With fourth-quarter results behind the company, we could become more constructive on the name, as we believe that the company's 2007 earnings power may be substantially better than expected," says Bonello, who currently has a market-perform rating on the stock. So "we intend to re-evaluate our estimates and rating following the conference call this morning."

Dark Industry Prognosis

To be sure, Universal's stock started to recover once that conference call kicked off. But some experts see even tougher times ahead.

Earlier this month, Fitch credit analyst John Wells warned of mounting industry challenges beginning next year. Wells covers nonprofit hospitals that share many of the same problems as their for-profit peers.

Looking ahead, Wells mentions several revenue threats in particular. For starters, he believes that managed care companies -- by far the most generous payers -- will start offering smaller, single-digit reimbursement increases going forward. He believes that Medicare, faced with a big tab from its new drug coverage, could seek some cutbacks as well. And he calls the outlook for Medicaid even "bleaker."

Wells also foresees rising expenses for the group. He believes that hospitals face major capital expenditures going forward. Meanwhile, he expects bad debts from the uninsured to keep on climbing in the future.

Thus, all in all, Wells feels cautious about the industry's prospects.

"Fitch expects 2006 operating margins will be no worse than Fitch's 2005 median operating margin," he notes. "However, due to potential declines in Medicare reimbursement, a downward shift in growth rates on payor contracts and growing capital needs in the sector, Fitch remains skeptical about the sustainability of current trends beyond 2006."