The Vital Signs on Five Top Hospital Stocks

The first hospital stock earnings season since the passage of health care reform is about to start. Can the recent rally in the health care stocks continue? Here are five hospital stocks to watch.
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NEW YORK (TheStreet) - Hospital stocks may not be the market's sexiest offerings.

Nevertheless, a lot of short-term money flooded into the sector with the immediate passage of health care reform, as short-term investors played the market euphoria.

Long-term health care investors were sitting on the sidelines during 2009 as the fate of health care reform remained uncertain. "The market hates uncertainty, and regardless of where individual companies shake out in health reform, at least investors now know what rules will be," said analyst David MacDonald of SunTrust Robinson Humphrey.

These investors may have been waiting out the short-term market euphoria in the days around the actual passage of the health care reform package, too.

Is the first earnings season without the health reform overhang the time to consider reinvesting in hospital stocks? "The near-term risks before these health care stocks benefit from reform dampens excitement, but long-only investors are thinking that even a few years off, it's time to start looking," said Mike Wiederhorn, health care analyst at Oppenheimer & Co.

There was at least one anecdotal sign ahead of the first hospital earnings report of the season --

Community Health Systems

(CYH) - Get Report

reports after the close of the market on Wednesday -- that investors were gearing up for health care investments. On Tuesday, shares of Community Health Systems hit a new 52-week intraday high, and the trading volume in Community Health Shares was at twice its average daily volume.

Community Health wasn't the only rally stock on the day before its earnings among hospitals.

Tenet Healthcare

(THC) - Get Report

,

LifePoint Hospitals

(LPNT)

, and

Health Management Associates

(HMA)

were all rallying with even greater share gains on Tuesday than Community Health's 4% share price hike.

Another intriguing sign in the hospital sector is that

HCA

has reportedly been testing the waters for a return to the public markets.

HCA, the hospital chain founded by the father of former Senate majority leader Bill Frist, was taken private four years ago in a $33 billion leveraged buyout led by

KKR & Co.

and

Bain Capital

.

Jason Gurda, an analyst at health care securities specialist firm Leerink Swann, said that since HCA was taken private three years ago, the timing of a potential return to the public markets may just be the normal course of the private equity exit strategy. At the least, the Leerink Swann analyst said HCA's plans could draw more attention to the group, and other health care market watchers have opined that the potential benefits from health care reform are among the main reasons that HCA could come back to the markets with the biggest IPO in two years.

"Hospitals are one of the primary beneficiaries of health care reform, and when HCA went private three years ago, there were negative trends including a rising number of uninsured patients and bad debt," Gurda said.

HCA still has the highest debt ratio among big hospital operators, and recent reports have noted an IPO would allow HCA to pay down existing debt. Taking a broader view, the Leerink Swann analyst said, "Now maybe we're starting to see a light at the end of the tunnel."

"There are still lots of health care generalist investors on the sidelines, and some of that money will come back into hospital land first because the group definitely has room for improvement," said Oppenheimer's Wiederhorn.

The five stocks covered in the following earnings preview include the biggest hospital stocks, and a few stocks in the broader health services category, from the bellwether hospital stock Community Health Systems to resurgent hospital dogs like Tenet and one-time fraud-headline fodder-maker

Healthsouth

(HLS)

.

"Keep in mind that 80% of return in hospital stocks is getting the group call right. Either they all work, or all don't work," said Leerink Swann's Gurda.

Community Health Systems

(CYH) - Get Report

is first out after the market close on Wednesday.

Earnings Date:

earnings conference call, Thursday, 11:30AM ET

Consensus Estimate:

74 cents earnings per share

First Quarter 2009 EPS:

63 cents earnings per share (5% outperformance of Street estimate of 60 cents EPS)

52-Week High Share Price

$42.01

Current Share Price:

$41.40

Key Issues and Earnings Themes:

Community Health Systems is the bellwether stock in the hospital sector for a reason: it has performed better on a more consistent basis than its peers -- and when HCA went private three years ago, it left Community Health Systems as the biggest public hospital operator on the block.

No big earnings misses by hospital stocks in the quarter, on either the operating numbers or bad debt, and more investors should become positive on the sector. "I think get if after one or two reports things look good, more money will flow to hospital stocks, and I think Community is your earnings read now," Oppenheimer analyst Wiederhorn said.

Two of the bigger hospital stock "read-throughs" in the first quarter are related to the severe winter weather and the weak flu season. The first quarter will not be the typical hospital first quarter because of these two factors, according to analysts, and volume growth should be lower than usual.

The recent rally in the stocks, coupled with the weaker than expected flu season and winter weather, could dampen immediate enthusiasm. Analysts say that if it had been a stronger flu season, there may have been more of a rush to get into these hospital stocks. Still, given that there are regular updates from the CDC during flu season, any weakness in patient volume should not be a big surprise to the market.

"I have fairly modest expectations for the first quarter, and volume will be the tough question," said Leerink Swann's Gurda. Guidance from hospitals on how much recovery can be expected in the second quarter will be closely watched.

Tenet Healthcare was one of the top-performing stocks in the S&P 500 in 2009. Of course, Tenet was one of the worst-performing stocks in the S&P 500 in 2008, so it had a lot of ground to make up.

Earnings Date:

May 4

Consensus Estimate:

8 cents earnings per share

First Quarter 2009 EPS:

8 cents earnings per share (166% outperformance of Street estimate of 3 cents)

52-Week High Share Price

$6.46

Current Share Price:

$6.28

Key Issues and Earnings Themes:

A second big issue in the long term will be for the hospital operators to show that they still have good control over costs, including labor costs. While there can be volume changes quarter to quarter, over time volumes are relatively stable, and pricing is tied to long-term contracts with rates locked in by the government.

"The real area where can see changes, and saw them last year, was what happened on cost side of equation, and specifically with labor costs coming down last year," said the Leerink Swann analyst. Can it continue or at least stabilize?

Tenet rallied on health reform, but also on margin improvement. Analysts are looking for more margin improvement from Tenet so the hospital operator can pay down debt, and possibly position itself for an acquisition.

Leerink Swann's Gurda said stabilization of margins would be satisfactory for him to keep an outperform on Tenet shares.

LifePoint Hospitals has been trading at its 52-week high. Is it a sign of lower than fair multiples for hospital stocks, or is it unlikely LifePoint shares can climb higher?

Earnings Date:

April 30

Consensus Estimate:

75 cents earnings per share

First Quarter 2009 EPS:

74 cents earnings per share (17.5% outperformance of Street estimate of 63 cents EPS)

52-Week High Share Price

$38.52

Current share price:

$38.47

Key Issues and Earnings Themes:

Leerink Swann says that while volume level is a general issue for hospital operators in the first quarter, LifePoint has been a volume laggard in the sector.

LifePoint made what Leerink Swann described as "modest improvements" in the second half of 2009. Still, as the hospital stocks tend to move as a group, LifePoint's earnings season performance may be as influenced by the overall volume story in the sector as in its company-specific volume outlook.

The "group-think" mentality on the hospital stocks also circles back to the trading multiple assigned by the hospital stocks by the market. The hospital stocks are up from historical lows in multiples, and remain moderately inexpensive, but the rally in 2009 and then again with the passage of health reform moved the stocks up from historical lows. Analysts also caution investors about using typical price-to-earnings multiple assessments on hospital stocks given their highly leveraged nature.

Nevertheless, in order for the hospital stocks as a group to move up from current share prices, the earnings may have to show that the margin improvement, or at least margin stabilization that was a big part of the 2009 story, will continue in 2010.

Health Management Associates was just ahead of Street expectations in its fourth quarter earnings. Will it be another in line quarter, or will Health Management Associates provide more of an earnings surprise, as it did in the first quarter 2009?

Earnings Date:

April 26

Consensus Estimate:

17 cents earnings per share

First Quarter 2009 EPS:

15 cents earnings per share (25% outperformance of Street estimate of 12 cents EPS)

52-Week High Share Price

$9.12

Current Share Price:

$8.65

Key Issues and Earnings Themes:

One point that the Street harps on in discussing the hospital stocks is the leveraged nature of these stocks.

Health Management Associates is a prime example. HMA's debt to capital ratio is at 85% -- according to Oppenheimer & CO. data, among the highest debt ratios in the hospital sector. Between 1995 and 2006, debt to capital was on average closer to 50% for hospital operators.

Community Health Systems is at a 79% debt to capital ratio. Long-term, that leverage can work in the hospital operators' favor. Short-term, investors need to consider their level of risk appetite when considering investment in the hospital stocks.

Leverage in the hospital stocks also highlights the ongoing issue of bad debt exposure for the hospitals. Analysts say that while the benefits of health care reform are years out, the issue of bad debt can rear its ugly head in the immediate future, as the recovery in the U.S. economy is still far from a sure thing, especially when it comes to employment.

Any negative earnings surprises from the hospital stocks related to bad debt could stifle investor interest in the longer-term play on these stocks related to health reform. Bad debt still has room to move higher, according to Leerink Swann analyst Jason Gurda.

Healthsouth is a health services play, as opposed to a hospital stock. While patient rehabilitation facilities are also located within most hospitals, Healthsouth controls approximately 50% of the patient rehabilitation market.

Earnings Date:

May 4

Consensus Estimate:

43 cents earnings per share

First Quarter 2009 EPS:

39 cents earnings per share (77% outperformance of Street estimate of 22 cents EPS)

52-Week High Share Price

$20.76

Current Share Price:

$20.63

Key issues and earnings themes:

Healthsouth's former CFO from its fraud days at the beginning of the past decade was released from federal custody last week. It's safe to say that the former CFO Bill Owens is not headed back to a corner office at the health services company.

The current Healthsouth management team, in fact, has done a much better job in executing on growth in the core patient rehab business and in keeping costs down instead of making numbers up, and sentiment has been positive on the health care stock. Almost every major expense item as a percentage of revenue was down in 2009 versus the previous year, and SunTrust analyst David MacDonald still thinks that Healthsouth has levers to pull in expense reductions.

Healthsouth has also given previous indications that it will be focused on investment spending in 2010, so investors will need to monitor what management says about managing expense reductions and spending throughout the year.

Healthsouth is a health care stock that could be negatively impacted by the severe winter weather, too, but analysts think that risk has been priced into the stock, even if it makes the growth profile a little disappointing in the quarter.

"We think events will take this stock higher over time, and we think 2010 guidance is overly conservative," MacDonald said.

-- Reported by Eric Rosenbaum in New York.

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