Summary:
Universal Health continues to benefit from higher number of Medicaid and Medicare
patients, which lowers uncompensated charges thereby driving top-line growth.
Moreover, accretive acquisitions present significant growth opportunities in the
behavioral market. The recently announced share buyback program will boost
earnings in 2016. Meanwhile, estimates have been stable lately ahead of the
company’s second-quarter earnings release. We note that the company has positive
record of earnings surprises in recent quarters. However, frequent acquisitions
present integation problems. Moreover, higher level of debt remains a significant
headwind.
Reasons To Buy:
- Currently valued at $2.9 trillion, the U.S. healthcare industry is expected to grow by leaps and bounds in the coming years as the population ages. The rising number of baby boomers, who are expected to account for more than 20% of the total U.S. population by 2029, boosts demand for healthcare services. Per the Centers for Medicare and Medicaid Services’ (CMS) projection, total U.S. healthcare spending is poised to rise 6.1% annually on an average between 2016 through 2024, as a result of the increasing number of insured patients, faster projected economic growth and an aging population. We believe that these trends present significant growth opportunities for Universal Health.
- Universal Health is expected to significantly benefit from the favorable Obamacare ruling passed in late June this year. A broader insured customer base will not only lower charity care and bad debts but also increase admission rates on the back of improving affordability among patients. In 2015, net revenue per adjusted admission inched up 3.9% year over year. We believe lower amount charity care and uninsured discounts will improve top-line growth over the long term.
- Over the years, acquisitions have played a key role in building Universal Health’s growth trajectory. The company spent $534 million on acquisitions that added almost 700 beds to its overall facilities. In Feb 2015, the company bought Orchard Portman House Hospital, a 46-bed behavioral health care facility located near Taunton in the U.K. Further, in August, Universal Health took over Alpha Hospitals Holdings Limited in the U.K. The Alpha Hospitals takeover expanded Universal Health’s tally to 21 hospitals and approximately 1,100 beds in the nation. In October, the company acquired Foundations Recovery Network for approximately $350 million. This transaction expands Universal Health’s footprint in the U.S. by adding 322 residential beds across 4 facilities and 8 outpatient centers. The company further plans to set up 140 beds over the next 12 months. We believe the company will continue to pursue acquisitions that will help it to expand its domestic as well as international presence.
- Behavioral facility acquisitions help Universal Health to win market share in the fast growing addiction and mental health disorder market. New laws (2008 Mental Health Parity and Addiction Equity Act as well as Obamacare) have raised the insurance coverage for patients suffering from substance abuse as well as mental disorders, which is a major positive for companies like Universal Health. The company focuses on behavioral indications like eating disorders, sexual trauma, Autism as well disorderliness in the military through its patriot support program. These will further boost admission rate thereby driving top-line growth over the long term.
Risks:
- Since inception, Affordable Care Act (ACA) or Obamacare has significantly benefitted the hospital industry, including Universal Health, by increasing the insurer base and lowering uncompensated charges. However, the upcoming presidential elections can upset this momentum as Republicans continue to oppose the various provisions of law. A Republican president at the White House will likely spell doom for the ACA, which does not bode well for the whole hospital industry in our view.
- Universal Health derives a significant portion of its operating revenues (35% in 2015) from the Medicare and Medicaid programs. The company generates $90 million of Medicaid revenues annually from each of the following states – Texas, Washington, D.C., California, Nevada, Illinois, Pennsylvania, Virginia, Florida and Massachusetts. Thus, any cut in state government reimbursements owing to budgetary constraints may impact the company’s overall financial performance. The hospital service industry will face approximately $600 billion in reimbursement cuts over the next decade, and Congress has ordered a number of cuts in hospital payments to fund the increase in physician payments. We believe that this is a potent headwind for the company, especially for the long term.
- Universal Health continues to acquire a large number of hospitals. While this improves revenue opportunities, it adds to integration risks. The frequent acquisitions may impact its balance sheet in the form of a high level of goodwill and intangible assets, which totaled $3.60 billion, or 37.3% of its total assets as of Dec 31, 2015. Frequent acquisitions are also a distraction for management and could impact organic growth, going forward.
- Universal Health’s balance sheet is highly leveraged. As of Dec 31, 2015, total debt stood at $3.45 billion. Such high debt levels may limit the company’s expansion plans and aggravate risks. Higher interest expense on debt is also expected to impact profits.
