Bad Debt Hammers HCA

The ailing hospital industry just keeps getting sicker.

HCA ( HCA), the biggest player in the for-profit group, has slashed its earnings guidance due to a crippling bad debt problem that continues to worsen. Meanwhile, Tenet ( THC) -- HCA's largest competitor -- added two new probes to the long list of investigations already facing the company.

Both stocks took immediate hits following Wednesday's news. The losses proved contagious, spreading to other hospital operators such as Triad ( TRI) and Universal ( UHS).

Early Wednesday, HCA diagnosed its first quarter as a weak one and gave no hope for an immediate recovery. The company cut its quarterly profit estimate to 69 cents a share -- 7 cents below Wall Street analyst expectations -- and reduced the full-year guidance it had maintained, despite rising bad debt, just two months ago. It now expects to deliver full-year profits of $2.60 to $2.70 a share, down a quarter from the prior range, even after recognizing gains from favorable malpractice developments. The company blamed the shortfall on a surge in uninsured patients who now account for 12% of its net revenue.

"As I have commented on many occasions over the past two years, the most significant challenge the hospital industry faces is the growing number of uninsured and underinsured in this country," HCA CEO Jack Bovender stated on Tuesday. "It is time for all sectors of society, both public and private, health care and non-health care, to participate in solving this societal issue."

Heal Thyself

Peter Young, a business consultant who caters to the hospital industry, viewed Bovender's comments as a "clear warning of the financial problems facing all hospitals" due to a surge in nonpaying patients. But he expressed little surprise about the industry's mounting problem.

"The news from HCA was not unexpected by seasoned hospital operators and consultants more in touch with real-time operations of hospitals," Young said. "I hope the industry does not worsen, but I am not optimistic near-term."

Indeed, Young believes the sector could still be another 14 months away from seeing bad debt improvements.

In the meantime, some are questioning HCA's ability to diagnose its own problems. Morgan Stanley analyst Gary Lieberman warned in February that HCA had left itself "little wiggle room" after it failed to adjust its full-year guidance to include a projected increase -- totaling 28 cents per share -- in its bad debt expense. But with uninsured admissions rocketing, particularly last month, Lieberman believes that HCA finally had "no choice" but to lower its guidance.

"This issue is particularly concerning for the company since it has yet to accurately anticipate its bad debt trend," noted Lieberman, who has an equal-weight rating on HCA shares.

Lehman Brothers analyst Adam Feinstein voiced similar concerns. He found HCA's latest bad debt adjustment surprising, especially following a number of similar charges taken by the company last year. And he pointed to "continued evidence" that HCA has been underreserving for bad debts for some time.

Feinstein also pointed out that HCA's earnings miss could have been larger. He calculated that the company had included up to 8 cents worth of unexpected malpractice benefits into its new full-year estimate.

"As a result," he said, "we believe that the decline in guidance is more significant than the headline may suggest."

Feinstein did point to rebounding admissions -- which jumped an estimated 2.5% -- as a "bright spot" in the quarter. But he also noted that much of the increase stemmed from uninsured patients whose unpaid bills will only compress the company's margins further.

HCA's stock plunged 7.8% to $39.28 on Tuesday's dismal update. Meanwhile, Lieberman questioned whether the company's warning could signal more bad news to come.

"The continued deterioration in HCA's bad debts obviously raises the question of whether other hospital companies will also experience additional issues with their bad debts," he stated.

Urban Blight

Leerink Swann analyst Kate Carr went a step further by predicting that three urban chains -- Triad, Universal Health and Tenet -- would be particularly vulnerable to sympathy pains on Tuesday. Almost on cue, all three racked up some of the biggest losses in the sector.

Triad spiraled 6% to $31.27 despite some expectations that the company's own bad debt problems may be moderating. Universal slid 2.8% to $43.11. And Tenet -- hit also with news of two fresh government probes -- plunged 4.1% to $10.53.

Following HCA's warning, Tenet said on Tuesday that federal prosecutors have launched new investigations of two Southern California hospitals that were already under scrutiny. The U.S. Attorney's office in Los Angeles has asked for coding and billing information related to 353 cases handled by the Comprehensive Cancer Center at Tenet's Desert Regional Medical Center in Palm Springs. The same office is also requesting information about the relationship between Tenet-owned Centinela Hospital Medical Center in Inglewood and an independent home health placement service.

Desert Regional is already under investigation for its aggressive collection of generous Medicare "outlier" payments in the past. It has also been highlighted for operating one of the most expensive operating rooms in the country and charging high prices -- for cancer treatment in particular -- by local newspaper The Desert Sun. In addition, the Sun has reported, the same hospital has been sued for allegedly defrauding Medi-Cal and last year paid a fine for improperly disposing of its medical waste.

If anything, Centinela faces even harsher allegations. The hospital is one of seven Tenet-owned facilities in Southern California being questioned about its financial arrangements with local physicians. It is also one of three in the area that has seen its cardiac unit attract increased government scrutiny. Moreover, the Los Angeles Business Journal reported last month, the hospital's busiest cardiac physician practice has fielded a subpoena of its own.

Tenet has already paid a record-setting fine to settle allegations that it profited from unnecessary cardiac procedures carried out by its busiest heart surgeons in Redding, Calif. The company has since stated, in its latest annual report, that it believes that "all aspects of its relationships with physicians potentially are under review."

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