Trying Times for Triad

The hospital chain's soft 2006 guidance could point to more sectorwide struggles.
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Triad Hospitals

(TRI) - Get Report

may have dashed some hopes for a quick hospital sector recovery.

The Texas-based hospital chain issued disappointing guidance on Monday, suggesting another tough year for the group. It fell short of 2005 expectations as well.

The company blamed rising bad debts from the uninsured -- along with subsidies for doctors who help treat those patients -- for much of the pain.

Excluding special items, Triad expects to post 2006 earnings of $3.04 to $3.16 a share. Wall Street had been looking for profits to come in a penny better than the high end of that guidance.

Meanwhile, Triad plans to make between 65 cents and 67 cents a share for the fourth quarter and between $2.78 and $2.80 for 2005. Analysts were instead looking for fourth-quarter and 2005 profits of 69 cents and $2.84 respectively.

Triad's provision for doubtful accounts, which spiked during the fourth quarter, continues to hurt results. Excluding new discounts for the uninsured, the company believes that allowance jumped to between 12.5% and 12.7% of net revenue during the latest quarter -- and will likely hover in the 12% range throughout this year.

"This compares to 10.9% through the first three quarters of 2005," noted Ryan Beck & Co. analyst Robert Mains, who has a market-perform rating on Triad's stock. "We do not know the reason for this increase, nor whether it is a Triad-specific or industry-wide problem. (But) this disclosure could adversely affect hospital stocks today."

CRT Capital analyst Sheryl Skolnick was concerned even after Triad offered an explanation for its rising bad-debt ratio. Essentially, the company said it had adopted a new -- and more conservative -- method for calculating its allowance for doubtful accounts in the latest quarter. But Skolnick wonders why Triad, which has enjoyed lower bad-debt expenses than some others in the past, has suddenly made this shift just now. She questions other changes -- including higher volume expectations -- as well.

"This suggests that there is more risk in the numbers now," says Skolnick, who has yet to initiate ratings on the hospital companies. "That's what I'm concerned about. I sense a deterioration in this business, and I wonder how much management really understands" the situation.

Triad dropped 53 cents to $41.29 on the company's downbeat report.

LifePoint Hospitals

(LPNT)

, which is slated to issue guidance of its own later in the day, slipped 10 cents to $36.15.

Skolnick looks for really bad news there. She believes that LifePoint has been hit hard by weak volumes -- due to the slow flu season -- and recent Medicaid cuts in some of its major markets.

"I think the fourth quarter is going to be close to a disaster for them," she says. "It's not going to be pretty."

Double Whammy

Still, hospital bulls continue to hope for the best.

To be fair, most analysts have by now learned to pay close attention to bad debts from the uninsured. Yet, some experts feel, they seem to be overlooking a closely related problem.

"Hospital bad debt results from a hospital service, but physicians associated with the service incur bad debts as well," notes Peter Young, a business consultant at HealthCare Strategic Issues. "The Street has been soft on hospital costs and has not focused on questioning the increasing costs to keep physicians on call for emergency rooms and specialty services."

Triad itself has sure taken notice. The company specifically blamed "subsidies for hospital-based physician services," together with higher utility costs, for an expected 14-cent hit to this year's results.

But Young suspects that other hospital companies could face even greater exposure. He points to those with multiple facilities in Florida -- including industry giants

HCA

(HCA) - Get Report

and

Tenet Healthcare

(THC) - Get Report

-- as prime examples. Notably, he says, Florida hospitals have struggled especially hard to attract enough physicians to cover calls in busy emergency rooms that have been treating more and more patients who have no means to pay.

Young cites a recent study published by the Florida Hospital Association when making his case. That study has predicted that physician shortages, coupled with growing crowds of uninsured patients, could soon lead to "crisis" situations for the state's hospital emergency rooms.

Already, the study notes, many physicians have chosen to work in other states -- where compensation looks more attractive -- or practice in freestanding outpatient centers. In response, the study has found, hospitals have been shelling out more money to those physicians who will work for them. However, it concludes, they cannot keep on doing this forever.

"The amount paid for E.D. on-call coverage by those hospitals varies by specialty and by hospital but can add up to a substantial amount of money," the report states. "While the task force recognized that this practice is occurring, it also recognizes that this is not a long-term solution and is not economically sustainable."

Thus, the state hopes to find better answers for the future. In the meantime, however, it struggles to serve one of the largest uninsured populations in the country.

Still, the state's situation is simply worse than most. Notably, Triad faces similar challenges without operating any facilities in Florida at all.

That development has apparently caught some experts off guard.

"We are trimming our EPS estimates and price target for Triad Hospitals based on the company's guidance, primarily due to higher bad debt and other operating costs," wrote Mains, who now values the company's stock at $40 a share. "While we anticipated most of these items, we underestimated their impact."

Hopeful Bulls

Meanwhile, JP Morgan analyst Andreas Dirnagl actually reiterated his overweight rating on Triad's stock following the company's disappointing report. He portrayed management's guidance as "clearly conservative" and predicted a possible rebound for the group.

"We continue to believe that 2006 could be a year of stability -- and even improvement -- for the sector as a whole, given a stronger U.S. economy," wrote Dirnagl, whose firm counts Triad as one of its clients. But "if instead we experience a downturn in the labor market from here, such that admissions and bad-debt trends do not improve as expected, we would consider taking a more negative stand on Triad shares."

Still, some experts doubt that even labor gains will cure the bad-debt problem. They point out that many companies have stopped offering affordable health insurance to their employees.

Nevertheless, some analysts continue to find hospital stocks attractive. John Ransom of Raymond James did lower the bar for LifePoint ahead of the company's scheduled update. He now expects the company to generate earnings of $2.70 a share -- well short of the $2.87 consensus estimate -- in 2006. However, he looks for real improvements after that time.

"Despite our tempered 2006 forecasts, we maintain our bullish stance on the company's 2007 earnings power, as the company's rural-market focus should continue to generate favorable volumes and pricing as well as lower bad-debt risk than the urban providers," wrote Ransom, who has a strong buy recommendation on the company's stock. "We consider LifePoint a key growth story for 2007 and beyond."

Raymond James provided investment banking services to LifePoint last year and expects to do so in the coming months as well.