|Shares Out. (in M):||54||P/E||12.6x||11.0x|
|Market Cap (in $M):||1,500||P/FCF||na||na|
|Net Debt (in $M):||1,280||EBIT||318||334|
|TEV (in $M):||2,780||TEV/EBIT||8.7x||8.3x|
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US hospital stocks are trading well below their historical ratings and at a significant discount to international peers. I am recommending Lifepoint Hospitals (LPNT) as the best entry point because it is cheaper than it's US peers even though it has generated the highest ROIC.
Mcap = $1 500mil
EV/EBITDA = $2 780mil
TTM EBITDA = $ 472mil (continuing operations)
EV/EBITDA = 5.9
TTM EPS = $2.62 (continuing operations)
PE = 10.5
LPNT is currently trading at a 33% discount to it's historic EV/EBITDA multiple = 8.8 and at a 29% discount to it's historic average PE = 14.7.
There is a potential 36% return if earnings grow by the predicted 6% and the stock re-rates by 30% to it's historic averages.
Valuation Relative to Peers
CYH trades at an EV/EBITDA of 7.2 and a PE=11.3.
On the surface CYH's ratings is in line with LPNT. However, on my preferred EV/EBITDA metric one needs to adjust for minority earnings in CYH. After adjusting the EBITDA for the minority share which is not earned by ordinary shareholders CYH trades at 9 times EBITDA.
The re-rating that I am betting on will apply to all US hospital stocks and I am only comparing LPNT to CYH to highlight that LPNT is potentially the cheaper entry point.
I also prefer LPNT because it has generated a superior ROIC as I will show below, but, first some background.
LPNT was spun off from HCA in 1999. At the time of the spin-off the 23 non-urban hospitals were not money spinners. The hospitals were turned around by investing in the hospitals and hiring physicians in a successful attempt to prevent patients from driving to major cities for better treatment.
From 1999 to 2004 revenues grew from $500mil to $1 000mil. In 2005 LPNT bought Province Healthcare for $1 700mil increasing the number of hospitals to 50 in 19 states.
Today, LPNT operates 49 hospitals which house 5 824 beds. 44 of these hospitals are operated in small towns where LPNT's hospital is the only hospital in the community. Seven of the hospitals are leased.
Revenues for 2008 grew to $2 700mil, 40% from Medicare+Medicaid, 45% from HMO's etc and 15% self pay and other. Even though LPNT make no margin on Medicare + Medicaid EBITDA margins have averaged between 17% and 20%. (More recently closer to 17% because of a 200bp increase in bad debt as a percentage of revenue.)
In addition to bad debt the other major costs are salaries (39% of revenue) and supplies (14% of revenue).
The return that LPNT has been very impressive outpacing it's competitors and many other long lived assets such as casinos.
The table below is taken directly from the cash flow statement. The goal is to calculate the total amount of assets (including net working capital) added to the left hand side of the balance sheet. The earnings power of the assets is represented by the EBITDA and the ROIC is the EBITDA divided by the total amount spent on assets.
|Invest in Assets+NWC||Cumulative Investment||Ave Investment||EBITDA||ROIC|
The table shows that a total of $2 937mil has been spent on assets which generated $466mil of EBITDA in FY2008. This represents a 16.4% return on investment, hich, should turn higher when improved economic activity allow bad debts to ease. (Note the $2 937mil equals the current EV.)
This is an impressive return compared to 10.3% return earned off the $14 000mil CYH spent on assets. THC earned 4.5% on $17 000mil.
It is also very impressive relative to other long lived assets. For instance, MGM spent $18 000mil to earn 10.3%, PENN spent $4 380mil to earn 14% and SPG spent $18 300mil to earn 14.3%.
Because hospital ROIC appear to vary widely it would be difficult for a regulator to target lower returns without punishing the more efficient hospitals. However, this regulation to drive the affordability of health remains a constant threat which must be addressed.
Around the world hospitals are heavily regulated assets often because a large portion of their revenue streams come from the government. The other elephant in the room are the private medical funds which demand discounts for volumes. Because the purchasers of medical services are so large hospitals are often price takers. While this is not a great position to be in purchasers of these services have to allow hospitals to earn an economic return on thier capital in order to ensure that the hospitals remain viable.
It is a sad fact of life that we will spend 70% of our total health care bill in the last 10 years of your life. Populations of developed nations are ageing quickly and there is no prize for guessing that hospitals can expect an ever increasing demand for their services as the populations age. In order to meet this demand regulators will not be able to lower prices below levels that will not preserve and grow hospital capacity. As a result I think it is likely that the average hospitals will continue to earn a fair return on thier capital and more efficient hospitals will enjoy soem excess return.
Once this is accepted investors may well have to model lower returns than those generated by LPNT, but, because of the increased visibility the ratings should be higher than 6 times EV/EBITDA LPNT trades on. Anecdotal evidence for the higher rating which can be expected can be observed in the UK, Switzerland and Australia.
An interesting way to look at the ratings is to calculate what a bed costs and the EBITDA that bed generates.
LPNT has an EV of $2 790mil and 5 824 beds. This implies a value of $480k per bed. Each bed generates an EBITDA of $79k for a yield of 16.4%.
In contrast, a flurry of transactions in the UK and Switzerland appear to price beds at $2mil per bed. These beds only generate a return between 6% and 8%. (12 to 17 times EBITDA).
Ramsay Healthcare (RHC AU), with hospitals in Australia and the UK trades on an EV/EBITDA multiple of 9.5 and a PE of 21.
It is clear that these ratings are significantly higher than those on US hospital stocks.
It is interesting to note that the UK, Australia and Switzerland all have National Health Insurance which provides free medical services for the entire population. In each of these counties the government supplies over 80% of the health services.
The private sector, while heavily regulated, provides top-up services for those who take out extra cover to avoid waiting lists, for private rooms, to choose their doctor etc. Recently, in the UK, the private sector has also received work from the NHS to help the government clear their waiting lists.
These countries demonstrate that National Health does not mean that private hospitals dont continue to thrive. It is also clear that investors are prepared to pay very high multiples for these income streams. I expect the US hospital sector to re-rate when US investors figure out that HMO's and the government will be forced to allow private hospitals to earn an economic return in order to ensure that they can satisfy the growing demographic demand. I think LPNT is a good way to play the re-rating as their positioning and business model which allowed them to earn good returns in the past will allow them to beat the the "economic return" into the future.
Greater certainty wrt health care reform
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