Hospital chains like Tenet Healthcare ( THC) and Universal Health Services ( UHS) have just suffered through an especially painful third quarter.

Both companies, along with industry giant HCA ( HCA), weathered serious damage as a result of two recent hurricanes. Moreover, they have taken the big storm-related hits at a time when major challenges -- such as weak volumes and bad debts from the uninsured -- continue to hurt the industry as a whole.

Thus, some experts have started bracing for poor results from the group. Lehman Brothers analyst Adam Feinstein, in fact, downgraded the entire sector from positive to neutral on Monday in anticipation of a "very tough earnings season" for most of the companies he covers. (Lehman Brothers does and seeks to do business with companies covered in its research reports.)

"We believe it was a stormy quarter for the health care facilities sector -- both figuratively and literally," Feinstein explains. "We have very low visibility, and the only thing we are certain about is that there will be continued 'uncertainty' for the remainder of the year."

Previously, Feinstein notes, investors had hoped to see the hospital industry make some progress after a particularly rough June quarter. Instead, he notes, the sector found itself wounded further by hurricanes Katrina and Rita.

Still, he stresses, the group was hurting even before that destructive weather hit.

"We believe that the timing of the storms could not have been worse, with companies already experiencing lower utilization trends," he says. "As a result, we suggest that many companies will view this as a 'free pass' and take this opportunity to reduce expectations (or 'reset the bar'). Although the market may look past this issue since hurricanes are an extraordinary item, we do not anticipate a meaningful uptick in volumes anytime soon."

Indeed, Feinstein singled out one company with limited hurricane exposure -- Health Management Associates ( HMA) -- for an individual downgrade on Monday. He cut his recommendation on LifePoint Hospitals ( LPNT) from overweight to equal-weight as well.

Shares of HMA slid 1.7% to $23.07 on the report. LifePoint's shares fell an even harder 3% to $42.40.

Ugly Duckling

Looking ahead, ailing Tenet should once again report the ugliest quarter of all.

As Feinstein points out, Tenet operates six hospitals in the Gulf Coast region devastated by Katrina -- including four that remain closed even today. In addition, he notes, the company runs another four hospitals in the Houston area that lost business as a result of Rita even if they did escape serious damage.

Now, Feinstein worries about Tenet facing yet another storm-related hit going forward.

"Tenet notes in its 10-Q filing that it is pursuing purchasing a reinstatement of flood limits with its current insurance carriers or possibly purchasing replacement coverage," writes Feinstein, who has an underweight rating on the stock. "While this seems prudent, we note that this disclosure also leads to questions regarding the adequacy of the company's current coverage due to its significant exposure in New Orleans and potential exposure from other hurricanes that could strike this year."

In the meantime, some experts believe, Tenet could face some legal exposure as a result of the fierce hurricane that has already passed. The company has come under intense scrutiny because many patients at one of its New Orleans hospitals died in the aftermath of Hurricane Katrina.

Just this weekend, in fact, officials from the Louisiana attorney general's office used a search warrant to obtain records from that particular facility.

"For the past several weeks, we have been working cooperatively with the Louisiana attorney general's office to review conditions at the hospital and the evacuation process in the post-storm period," Tenet said when disclosing news of the search on Sunday. "We have provided the attorney general with medical records and other information and will continue to do so."

Meanwhile, Tenet itself continues to bleed. Feinstein believes the company will report a loss of 7 cents a share -- 3 cents worse than the consensus estimate -- when it provides a quarterly update next month.

The company's stock, which topped $13 before the storms hit, tumbled 2.5% to $10.95 on Monday.

Universal Challenges

Universal fared better, slipping less than 1% to $47.25, despite its own hurricane exposure. Feinstein notes that Universal operates three New Orleans hospitals that now face an uncertain future.

"We highlight that it is unclear at this time as to whether UHS will remain in the New Orleans market," writes Feinstein, who has an equal-weight rating on the stock. "Hence, a sizable portion of the 7% of revenue that UHS generated from its three facilities in New Orleans will be at risk for the foreseeable future."

Universal faces other challenges as well. Notably, Feinstein points out, the company continues to struggle in its important McAllen, Texas, market.

"We believe that UHS could have managed through either of these issues individually," he says, "but the combined impact leads to reduced earnings visibility."

Feinstein, for one, sees a big miss coming. Specifically, he predicts that the company will report third-quarter profits of just 52 cents a share instead of the 64 cents Wall Street is anticipating.

Other Shortfalls

Feinstein believes that HCA will come up short as well.

He predicts that HCA, which operates several hospitals in New Orleans, will miss the 67-cent consensus estimate by 4 cents. Still, he sees the potential for upside if the company lays out plans for another big stock buyback.

HCA was the only hospital to hold its ground on Monday, inching up less than 1% to $48.30 a share.

Meanwhile, HMA fell on Feinstein's prediction of yet another rise in the company's level of uncompensated care. And LifePoint slid on his warning about lost volumes resulting from Katrina and, especially, Rita.

Going forward, Feinstein sees lingering problems for the hospital group as a whole. Indeed, he points to bad debt from the uninsured -- which has dogged the industry for years -- as the biggest challenge of all.

"Our extensive channel checks suggest that bad debt expense has not improved (with little improvement in the uninsured population) and will likely continue to persist at current levels for the remainder of the year," he says. "Although we believe that bad debt expense will be stable, we are now pushing back our expectation for improvement until next year. (And) it is our contention that bad debt expense must improve for the group to trade higher from current levels."

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