A Far-Larger Hospital and a Far-Larger Stock Position

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Jan 02, 2014

On Dec.23, Larry Robbins added Tenet Healthcare Corp. (THC, Financial). It was the third time he added the stock during this month, which makes me feel that he is betting in favor of a positive future for hospitals benefiting from the implementation of the health care reform.

Acquisition of Nashville-Based Vanguard Health Systems

Tenet Healthcare is an investor-owned health care services company whose subsidiaries and affiliates primarily operate 49 hospitals, 117 outpatient centers and Conifer Health Solutions (Conifer), which provides business process services to more than 600 hospital and other clients nationwide.

In October 2013 the firm acquired Vanguard Health Systems, getting “the best acquisition team” in the industry, company president and CEO Trevor Fetter said. With the acquisition the company plans to expand into new markets and projects annual revenue between $15 billion and $16 billion. The bad news is that debt levels increased to finance the deal with secured and unsecured notes at interest rates of 6% and 8.13%.

Analyst Recommendation

The firm is currently Zacks Rank #5 - Strong Sell, and it also has a longer-term recommendation of “Underperform.” Moreover, we found three severe warning signs issued by GuruFocus: The gross margin has been in long-term decline (the average rate of decline per year is 1.6%); over the past three years, the firm issued USD1 billion of debt; and the asset growth was faster than revenue growth, indicating less efficiency.

Valuation

In terms of valuation, its price-to-book ratio of 4.8 indicates a premium versus the industry average of 2.09 while the price-to-sales ratio of 0.45 is below the industry average of 1.2.

Earnings per share (EPS) increased by 14.3% in the most recent quarter compared to the same quarter a year ago and it has demonstrated a positive trend over the last year. We include in the next graph the stock price because EPS often lead the stock price movement.

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Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has decreased when compared to its ROE from the same quarter one year prior. This is a signal of weakness and a signal of warning for investors. Competitors such as Acadia Healthcare Company Inc. (ACHC, Financial) trade for 5 times book as well as have a positive ROE of 4.7%. Other alternative could be Community Health Systems Inc.Ă‚ (CYH, Financial) with a 9.7% ROE. But for those seeking great ROE, the option should be Health Management Associates Inc. (HMA, Financial).

Final Comment

Tenet Healthcare’s revenue growth has increased compared to the same quarter a year prior but still underperformed the industry average, and this is not a good signal in the sense that competitors are gaining market share. However, I would recommend the stock for long-term portfolios because it was one of the biggest deals in the hospital industry and we expect growth potential in the near future as more people will gain health coverage.

Hedge fund gurus have also been active in the company. David Tepper, Ray Dalio and John Griffin have invested in it.

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Disclosure: Damian Illia holds no position in any stocks mentioned.