Description

NOTE: We began the below write-up before Obamacare was proclaimed to remain “the law of the land” on Friday night. But our below thesis remains the same and obviously, in our opinion, is even better now.

We believe it’s an anomaly that HCA—a highly liquid, mega-cap, recessionary resistant, non-cyclical, growing business with no technological obsolescence risk, not over-levered, owns all its real estate, and is run by the best operators in its industry who are also excellent capital allocators—is trading at 12x this year’s earnings.

Hospital Corporation of America (HCA) is the largest hospital owner in the United States. It was founded by the Frist family, who built HCA from its first hospital in 1968 to the 171 hospitals and numerous other medical facilities that the company operates today. The family continues to own ~17% of the company.

There are around 5,000 hospitals in the U.S. Over one-third of them either break even or lose money. HCA, on the other hand, has consistently generated 13% profit margins on average for decades. We think HCA’s tremendous size—approximately 5% of all U.S. hospital services occur at an HCA facility— enables the company to benefit from scale efficiencies. Its purchase of $7 billion of supplies annually—versus a stand-alone hospital that generally spends a few million dollars—helps HCA to have some of the lowest supply costs in the industry. Its consolidation of administrative functions across its many hospitals—whether it is human resources, accounts receivable, purchasing, IT, insurance—further lowers its operating costs relative to smaller hospital organizations.

But HCA’s outstanding culture of efficiency is not achieved at the expense of quality care. More than three-quarters of HCA’s hospitals are on The Joint Commission’s list of Top Performers on Key Quality Measures, compared to less than one-third of all the hospitals reporting data.

HCA has uniquely positioned assets. It has hospitals located in 16 of the 25 fastest growing large U.S. cities, such as Nashville, Tennessee, Austin, Texas, and Orlando, Florida. Management’s smart selection of hospital locations in cities with above-average population growth should help HCA to continue to have above-average growth in its admissions.

Additionally, in the cities where its facilities are located, HCA builds out a hub-and-spoke model that creates a wide net for a patient to enter its system. This also helps to increase HCA’s admissions, and it leads to negotiating leverage with insurance companies. To use Nashville, Tennessee as an example, HCA—under its locally known brand TriStar Health—owns 125 different facilities centered around its 12 hospitals. These include freestanding emergency rooms, urgent care clinics, surgery and imaging centers, and physician clinics. HCA’s goal is to have a TriStar access point no more than 15 minutes away from every individual in Middle Tennessee. An insurance company would be hard-pressed not to have HCA in its network. And a Tennessean would be well advised to choose HCA, since its Centennial Medical Center is ranked one of the safest hospitals in America.

Investors currently seem to shy away from considering an investment in HCA because of frequent headlines about healthcare spending and proposals to repeal Obamacare. We think such headlines and generalizations are too hastily applied to HCA, and it is what allows investors to currently purchase this company at such a cheap price.

First, we believe material reimbursement cuts to hospitals are highly unlikely. 80% of hospitals in America are either not-for-profit or government-owned. Many, as mentioned, operate on razor thin or negative margins. Any significant cuts to hospital rates could put the U.S. hospital system—and potentially human life—into a precarious state. The hospital industry does not earn profit margins that justify substantial price cuts. Second, regarding the potential repeal of Obamacare, patients under this program represent only 2.5% of HCA’s volume and 5%-6% of its income. Simply put, HCA was significantly profitable both before and after Obamacare took effect.

HCA’s management are shrewd capital allocators, repurchasing the company’s shares at opportune times, such as last year when healthcare stocks lost favor with investors. Moreover, HCA’s management has earned a consistent 16% return on capital by reinvesting its profits to expand its facilities. Management thinks it will be able to reinvest profits at high returns for the foreseeable future due to population growth, aging baby boomers, and increasing life expectancies.

HCA currently trades at 12x 2017 earnings. HCA has the characteristics of a utility—it’s essentially a utility on healthcare: the demand for its services are largely inelastic and recession-resistant; the demand for its services will continue to grow indefinitely with the population (and possibly faster due to aging baby boomers); and the barriers to entry for new hospitals are enormous. Additionally, the amount of hospital beds per capita in the U.S. has consistently declined for 20 years (due to a decline in rural hospitals), from 4.5 hospital beds per capita to 2.8, creating a continuing tightening of capacity.

Utilities in the United States trade at an average of 22x earnings. (Alternatively, the S&P trades at 18x earnings, and HCA is growing faster than the average S&P 500 company and is arguably a higher quality business.) Should HCA—once the business is better understood and/or the scary healthcare headlines die down—trade at a similar multiple, its stock would be priced at $163 versus its current $86 price. That’s 90% upside, today. In a stock with which we see little downside risk.

And should HCA not be repriced immediately, time is still on your side as HCA should continue growing its EPS at double-digit rates through share repurchases and significant high-returning reinvestments into its business.

We can answer further questions in the Q&A, since we thought this posting is time-sensitive.

Catalyst

Friday's withdrawal of Trump/Ryancare.