Is Universal Health Services Stock a Bargain Following Hospital Closure?

Universal Health Services (UHS 0.58%) may be a good find for bargain hunters after a market sell-off triggered by a sharp decrease in fourth-quarter and full-year 2022 net income.

The quarterly profitability plunge to $174.8 million, down almost 27% year over year, appears to be largely the result of a one-time event: the hospital chain's decision to close its 282-bed acute care Desert Springs Hospital in Las Vegas this month. The company's operating expenses appear to have been growing faster than revenue across all of its acute care facilities, reaching $7.2 billion in 2022, or 94.3% of net revenues, compared with $6.4 billion, or 89.6% of net revenues, in 2021. 

Shutting down a hospital is an expensive business

Because of the hospital shutdown, the company took a pre-tax asset impairment charge of $57.6 million. CEO, President, and Director Marc Miller said in a Feb. 28 conference call that most of the hospital's employees will be transferred to other facilities. This may be a hint that the company is not planning a massive transition out of acute care -- it had 27 other inpatient acute care hospitals -- despite its decision to focus on growth in behavioral healthcare. Still, it should be noted that this is the fourth impairment charge UHS has had to absorb over the past five years, which could explain investors' caution with this stock.  

However, UHS' annual net income fell almost 32% year over year to $675.6 million, so the hospital closure wasn't the only factor. Miller pointed to a fourth-quarter decline in COVID-19 patients and inflationary pressures. Similarly, management pointed to the ongoing effects of COVID-19, which also include a clinical staffing shortage and inflation as affecting full-year results. The company receives government reimbursement for COVID-19 patients and expects to see $100 million of that phased out in 2023. These kinds of pressures are hardly unique to UHS; "last year was the worst financial year for hospitals and health systems since the start of the COVID-19 pandemic," management consultancy Kaufman Hall said in January.

Analysts see a profitable outlook for UHS in the coming years

Nevertheless, the company is still profitable, with the company's estimate of $10.00 adjusted earnings per diluted share in 2023 virtually converging with analysts' average estimate of $9.97, and comparing favorably with last year's actual EPS figure of $9.88. Analysts' average growth estimate for UHS over the next five years is 4.11% per year, down a bit from 5.8% over the past five years, but still strong. Over the past year, its share performance has been volatile and has only grown about 0.2% over a 5-year period so clearly, it's not a high-growth stock.

So what could drive the growth anticipated by UHS and analysts alike?

A focus on behavioral health

Hints about the company's future direction can be found in several announcements over the past three years about partnerships to establish new behavioral health facilities. As early as May 2020, the company pinpointed a large increase in behavioral health problems and concomitant demand for services as a likely result of the COVID-19 pandemic and the associated shutdowns. "As the pandemic subsides, we are ready to meet a massive pent-up demand for behavioral health services and support," Ethan Permenter, Divisional VP, Behavioral Health Division of UHS, said.

It seems the company has done just that with the following table outlining behavioral health facilities that have since been opened or proposed by the company.

Table by author. Data Source: UHS Press Releases.

It's true that most of these facilities were open by 2022 and earnings still plunged last year, but given the lower operating cost to net revenue margin for behavioral health than for acute care, it makes bottom-line sense for UHS to place its emphasis on the former. The company now operates 185 inpatient and eight outpatient behavioral care centers in the mainland United States, three inpatient facilities in Puerto Rico, and 143 inpatient and two outpatient facilities in the United Kingdom.

Furthermore, the broader significance of this focus is easy to see, in a climate in which mental health experts have been issuing increasingly urgent warnings about the shortage of mental health services in the United States. According to Fortune Business Insights, the U.S. behavioral health market is expected to grow from just under $80 billion last year to over $105 billion by 2029. Industry research company IBISWorld estimates that UHS has a 17.2% market share in U.S. psychiatric hospitals; the company itself has not offered any recent guidance on how much bigger its slice of the pie could grow. 

However, there is a risk for UHS that its behavioral health facilities could go the way of its acute care facilities, with operating expenses eating up almost all revenues. In 2022, operating expenses for UHS's behavioral facilities were $4.6 billion, 81.9% of net revenue, compared with $4.3 billion, or 80.6% of net revenues, in 2021.

UHS shares are in a slump, like its peers

UHS shares closed at $125.88 on March 21, down from $146 on Feb. 27 before the fourth-quarter and full-year 2022 results were announced. That steep drop might seem like a market overreaction to the one-time costs of the Desert Springs Hospital closure, but a comparison between the company's price-to-earnings ratio and that of its competitors shows it in the middle of the pack, amid unsettled market conditions.

UHS PE Ratio data by YCharts

This growing health provider with a firm plan to expand its offerings in the burgeoning behavioral health services market might deserve a second look; investors may want to at least hold onto any shares they have. And if the company can live up to the growth forecasts this year, it may prove to be a bargain after all.