Is This Hospital Stock Undervalued?

Tenet Healthcare Corp. (NYSE: THC  ) shares took a tumble recently, plunging more than 8% in one day after guidance missed analyst estimates. But are things at the hospital operator as bad as the share price collapse suggests? There is evidence that the stock sell-off may have been overdone. Compared to peers like HCA Holdings (NYSE: HCA  ) and LifePoint Hospitals (NASDAQ: LPNT  ) , Tenet looks an attractive investment consideration. Here are a couple of reasons why investors might want to look in to this hospital stock.

1. Shares appear bargain-priced
Tenet Healthcare's stock dive doesn't seem related to recent performance. The company's latest quarter looked fairly good. Revenue ballooned over 66% year-over-year, thanks to a recent acquisition. On a comparable same-hospital to same-hospital basis, revenue increased about 1%, helped by same-hospital surgeries growing a striking 21.5%.

Though current results were reasonably good, Wall Street seemed less taken with Tenet's 2014 guidance. The company expects adjusted EBITDA, or earnings before interest, taxes, depreciation and amortization, of between $1.8 billion to $1.9 billion, just shy of analyst expectations for $1.94 billion.

Tenet's anticipated EBITDA, a standard financial metric for the hospital industry, doesn't appear seriously deficient, however. It's an over 30% increase from that delivered in 2013 and also suggests the company's shares might be undervalued. Trading at around 2.4 times the low end of forecast, Tenet's market value looks heavily discounted to peer hospital owners like HCA Holdings.

HCA, one of the nation's leading health care services companies, also reported a fine recent quarter. Revenue increased 4.8% year-over-year and adjusted EBITDA grew 6.7%. Growth was primarily driven by a revenue per admission increase of 4.6% compared to a year earlier.

The company anticipates continued gains in 2014 with total revenues in the $35.5 billion to $36.5 billion range for a year-over-year increase of between 3.8% and 6.7%. EBITDA is expected to be flat to up 4.7% or between $6.6 billion and $6.9 billion.

A premier participant in the hospitals sector, HCA is currently priced around 3.3 times the high end of EBITDA guidance. While HCA probably deserves a premium valuation, its multiple spread to Tenet's appears to me to be excessively wide.

2. Long-term prospects look pretty good
Longer-term prospects suggest a higher multiple for Tenet Healthcare might be reasonable. Its $4.3 billion acquisition of Vanguard Health Systems in late 2013 should reap meaningful future benefits. Vanguard generated about $6 billion in annual revenue during fiscal 2013, so the acquisition should add that additional revenue to Tenet's numbers for 2014. Management expects to generate at least $100 million to $200 million in synergistic cost savings, so a good portion of Tenet's gains will likely be recognized in the latter part of 2014 and into 2015.

The company's Conifer Health Solutions subsidiary, an administrative services provider to the health care industry, should also provide a boost. Benefiting from the increased financial stress and complexity of running a medical facility, Conifer's nearly 75% year-over-year revenue jump in the latest quarter is a sign that demand for its services is growing rapidly.

Tenet could also expand through further acquisitions. Hospital system consolidation is a powerful trend. Besides Tenet's purchase of Vanguard, major industry participant Community Health Systems (NYSE: CYH  ) recently closed on its $7.6 billion buyout of competitor Health Management Associates.

Though Tenet needs to concentrate on paying down debt in the short run, I suspect that management will consider other mergers eventually. A potential target may be LifePoint Hospitals, one of the few remaining large publicly traded hospital chains. LifePoint reported its own impressive quarter recently. Revenue rose 6.6% from a year ago and adjusted EBITDA increased 10.1%.

The gains were helped by LifePoint's own network expansion strategy of acquiring smaller hospitals. The company expects another good year in 2014 with EBITDA gaining 4% to 10%. Currently trading at a robust 4.4 times the high-end of forecast EBITDA, LifePoint's position as a potential acquisition target seems well recognized by Wall Street.

Uncertainty remains a concern
The hospital industry does face issues. Consequences from the Affordable Care Act are still a mystery. While it's believed that the increased number of insured patients will reduce bad debt expenses and gradually drive hospital utilization higher, there is no assurance that the gains will be significant. But the relief is certainly needed. Bad debts are a major hospital problem, costing Tenet almost $1 billion last year, and weak inpatient admission trends are a nagging concern. For the fourth quarter, Tenet's admissions were down 3% and HCA's were down about 1%. These are comparatively good results when compared to LifePoint's decline of 5% and Community Health's 10% drop.

While assistance from the Affordable Care Act is a possibility, reimbursement cuts from Medicare and Medicaid seem inevitable. These government programs are key payers in the health care field, accounting for over 30% of Tenet's patient revenue last year, and if the programs focus on reducing provider rates and fees aggressively, it could be a major industry difficulty.

Summary
Tenet Healthcare disappointed Wall Street recently and paid the price. Its shares dropped over 8% in one day. There is evidence that the selling may have been excessive, however. Priced at an attractive valuation, compared to peers like HCA and LifePoint Hospitals, and possessing a hopeful future, Tenet may be a compelling investment consideration.

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