Healthcare stocks are generally considered a safe haven for investors during a difficult market, because sick people can't wait for an upbeat economy before getting the treatment they need. Despite this, the markets have been down on hospital stocks, as difficult operating conditions have hurt their bottom lines and caused several major companies to lower guidance for the year.
Even hospital service provider HCA Healthcare (HCA 2.94%), which owns the largest hospital network in the U.S, hasn't been immune. The company's stock has seen some significant ups and downs this year. After rallying from its summer slump in late July following a second-quarter earnings beat, HCA's stock is now trading more than 20% above last month's (and 52-week) lows. A closer look at the company's fundamentals suggests which direction the stock will take in the long term.
Stabilizing patterns
COVID-19 threw a curve ball at hospitals, disrupting typical patterns and causing overcrowded emergency rooms. Many people with less critical conditions chose to delay their elective procedures, and non-COVID-19 admissions dropped well below typical levels. Non-COVID-19 admissions hit a low 63% of typical levels in April 2020, while during the later outbreaks, such admissions were just 80% of usual levels.
This strained hospitals that were already operating on tight margins. Despite higher revenue in the first quarter, greater spending on salaries and supplies hurt the bottom line. But CEO Samuel Hazen pointed to improving labor conditions in the second quarter. HCA's labor turnover dropped 20%, and the company didn't need to rely as heavily on expensive contract labor. Although the quarterly net income of $1.4 billion was still below the $1.5 billion of the first quarter, earnings per share of $4.21 easily beat analysts' estimates of $3.70.
Hospital admissions numbers are now recovering, and HCA's management does not expect any long-term structural changes to healthcare. People have been returning to hospitals between COVID-19 surges, and admissions will likely stabilize at pre-COVID-19 levels over the longer term. And with time, management expects COVID-19 to follow more predictable seasonal patterns. This will make it easier for HCA to plan and allocate resources.
Size advantage
HCA has several elements working in its favor over the longer term. It operates with impressive economies of scale. HCA grabs 26% market share and is geographically spread from east to west across the country. The company is also well diversified across a mix of acute care hospitals, ambulatory services, urgent care centers, and physician clinics.
This allows the company to move resources to adapt to changing market trends. For example, over the past decade, surgeries have generally been moving toward outpatient settings, particularly from hospital outpatient centers to ambulatory surgery centers. These centers have lower overhead and can perform operations at lower costs than in a hospital setting. HCA has responded by shifting its assets toward outpatient beds. Year over year, HCA's number of acute care hospitals decreased from 187 to 182, while its number of outpatient surgical centers increased from 122 to 126.
Attractive valuation
HCA has a track record of strong growth on both the top and bottom lines. Over the past 10 years, the company's revenue has climbed steadily upward, growing annually at a rate of around 6%. Analysts expect similar performance in the future, with earnings per share expected to grow about 7% over the next three to five years.
The company has also been able to consistently convert its capital investment into growth. HCA's high return on total capital (ROTC) has now topped 15%, well above the 6%-8% standard among its hospital peer group. This is not an anomaly, as HCA has kept its industry-leading ROTC above 14% for the past decade, with only a brief dip to 11% at the start of the COVID-19 crisis. The company has steadily grown its capital investment, spending $1.1 billion in the second quarter, putting itself in a position for continued growth.
All in all, HCA still has a nice valuation despite the run-up in stock price. The trailing price-to-earnings ratio of 10 is near its lowest level in the past five years and below those of all of its major competitors except Tenet Healthcare (THC 3.17%). This is even though its revenue is expected to grow faster than the revenues of these same peers, and the dividend of 1.1% is higher than that of most other hospital stocks. So even if you missed the low summer price, it is still a good time to consider this stock.
