HCA Healing After Bad-Debt Scare

HCA ( HCA) spent the second quarter in the recovery room.

For the first time in a year, the nation's largest for-profit hospital chain is set to meet Wall Street expectations. The company, hurt in recent periods by an industrywide bad-debt problem, announced on Wednesday that second-quarter operating profits should match the consensus estimate of 65 cents a share. Including a favorable adjustment to liability insurance reserves, the company predicts that it will actually top expectations by 7 cents.

It also reaffirmed full-year guidance, cut last quarter, of $2.60 to $2.70 a share.

HCA's favorable prognosis pushed the company's stock up 2.6% to $41.70 in heavy trading Wednesday. The rally proved contagious, with other hospital companies -- including LifePoint ( LPNT), Tenet ( THC) and Universal Health ( UHS) -- racking up even larger gains.

But Peter Young, a business consultant who caters to the hospital industry, saw only a few bright spots in HCA's report. Namely, he said that HCA's higher net revenue per patient -- up 5.7% in the quarter -- indicates that the company has managed to refine its business to focus on higher-margin services and sicker patients. Still, he noticed troubling symptoms of ongoing problems at the company.

Most importantly, he said, HCA's hospital admissions -- up just 0.4% from a year ago -- show that patients continue to favor outpatient clinics or, faced with rising co-payments, delay treatment altogether. HCA admission growth fell sequentially as well.

Young also noted that HCA's bad-debt expense, while down from last quarter, remains far higher than historical levels. He's doubtful it will improve anytime soon.

"Reaffirming lower-end guidance and the reported numbers seemingly indicate the decline in operational performance has leveled," Young admitted. "But the industry's future is still fraught with risk."

Smoothing Out

Prudential analyst David Shove remains worried about the sector as well. Still, he did forecast a healthy quarterly checkup for hospital companies just ahead of HCA's announcement. In a research note published Tuesday, Shove said that a sudden rise in Medicare admissions last month should allow hospital companies to meet profit expectations and could even signal a positive change in volume trends going forward.

"Medicare hospital inpatient admissions in June 2004 rose by a startling 15.2% year over year, while outpatient visits rose a robust 17.5%," Shove wrote. "Compared to June 2003, both inpatient and outpatient volume growth was phenomenal."

Shove was previously concerned by May Medicare data that showed meager growth in volumes that broke a five-month cycle of strong increases. However, he now believes that the latest data "resoundingly squashes" the possibility that Medicare business growth has entered a downward trend. Indeed, he is convinced that the new Medicare figures -- even smoothed to offset monthly volatility -- clearly indicate that the favorable growth trend has "returned with a vengeance."

Shove considers the figures from Medicare, which accounts for roughly one-third of all hospital business, to be a "snapshot" of total hospital billings and industry trends. Still, he stops well short of abandoning his unfavorable view of the sector at this point. He believes that a number of challenges -- such as high bad-debt expense and labor costs -- could still threaten the industry this year.

For now, at least, HCA appears to be faring better. Just one quarter ago, the company was warning that unfavorable developments -- namely a huge spike in uninsured patients -- had crippled its performance. But the company's bad-debt expense has now fallen to a level below that previously forecast for the full year.

During the latest quarter, HCA said that its provision for doubtful accounts totaled $661 million, or 11.3% of net revenue. Those figures are down from $694 million and 11.7% of net revenue in the previous quarter. Quarterly bad debt, as a percentage of revenue, is also below the 11.5% level predicted for the entire year.

Still, an increase in charity care expense -- deducted upfront from total revenue -- accounts for much of the improvement. HCA wrote off $232 million worth of charity care, up $14 million sequentially, in the latest quarter. Thus, the company still provided $893 million worth of care for which it was never paid. It offered $912 million worth, or 2% more, of uncompensated care during its tough first quarter.

Charity Case?

Another hospital company, Health Management Associates ( HMA), has also kept its bad-debt expense down by classifying many accounts as charity care instead. By doing so, HMA has so far avoided a sectorwide trend of rising bad-debt expenses that could hurt the company's industry-leading margins. Still, at least one noted health care analyst has predicted that HMA may finally succumb to the industry's woes.

In May, Sheryl Skolnick of Fulcrum warned that HMA's practice of waiting 150 days to reserve for unpaid governmental accounts -- and the company's presence in major markets serving the uninsured -- could soon hurt its results.

HMA "may not yet realize the full depth of the problem with the uninsured and how bad its receivables really are," wrote Skolnick, who has long recommended selling HMA's shares. The current quarter "may be the first to surprise HMA."

More recently, TheStreet.com reported that HMA had actually found itself laying off dozens of employees at one of its hospitals due to financial problems. HMA spokesman John Merriwether downplayed the cuts, which eliminated 71 jobs at an Oklahoma hospital, as a "fairly routine phenomenon" that can occur during the slow summer months. But the reductions, announced in late June, came the very month when Medicare admissions were supposedly rocketing across the industry.

Brian Clemens, CEO of the affected HMA hospital, offered more details when speaking to the local newspaper. He told the Daily Oklahoman that Midwest Regional Medical Center had suffered "an atypical seasonal downturn this quarter that required us to promptly maintain our financial health." He pointed to "lower-than-expected reimbursements" as a factor.

Young quickly offered a translation.

"Sounds like management speak for bad debt," he declared.

Still, HMA jumped along with the rest of the hospital companies on Wednesday. The stock -- long favored by most health care analysts -- was up 3.4% to $21.87 halfway through the session.

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