Tenet Healthcare's High Debts & Expenses Raise Caution - Analyst Blog

On Nov 21, 2014, we issued an updated research report on Tenet Healthcare Corp. (THC). Earlier this month, the company reported third-quarter earnings that surpassed the Zacks Consensus Estimate but declined year over year on high expenses. We believe that high financial leverage, increased expenses and overhang of lawsuits will weigh on the company's financials going forward. However, product launches, incremental synergies from acquisitions and growth in outpatient business are expected to help in countering the negatives.

Tenet Healthcare serves a large number of uninsured and underinsured patients with a high burden of co-payments and deductibles. Consequently, the company has a high level of uncollectible accounts and rising bad debts. Moreover, the company has experienced high levels of operating expenses over the past few years. Operating expenses also increased in the first nine months of 2014. At present, Tenet Healthcare needs a prudent expense management strategy or else it could face severe margin contraction.

Moreover, inpatient revenues started declining from the beginning of 2013. Although inpatient revenues increased in the first nine months of 2014, the CMS' implementation of a 1% decrease in payments for hospitals is expected to weigh on inpatient revenues going forward. Moreover, Tenet Healthcare is a highly leveraged company. It deploys a substantial part of its cash flow to pay the interests on its debts, which leaves the company with limited funds to utilize for its operations, growth initiatives or capital expenditures.

However, the company's operating revenues have shown improvement over the past few years that raises optimism. Net operating revenues also increased in the first nine months of 2014 on account of higher patient volume, improvement in terms of the commercial managed care contracts and better performance in the Conifer services business. Moreover, if the California Provider Fee program is approved by the CMS at least before 2014-end, management stated that it expects the program to record increased revenues and earnings before interest, taxes, depreciation and amortization (EBITDA).

Over the years, Tenet Healthcare has been steadily expanding its operating capacity through acquisitions and alliances. Going ahead, the company hopes to continue acquiring hospitals and other healthcare assets to increase outpatient revenues. The outpatient business of Tenet Healthcare has generated higher margins than any other business lines of the company, also contributing largely to overall revenues. The acquisition and addition of outpatient facilities has brought the total outpatient center count to more than 200 at Sep 2014-end.

Tenet Healthcare continues to enhance business growth and optimize its capital structure through financial and strategic plans. Additionally, some provisions of the healthcare reform legislation signed in Mar 2010 are expected to benefit hospital companies like Tenet Healthcare. The company is presently slated to gain from the 2.1% increase in payment rates for IPF units as per the final rule issued by CMS.

Tenet Healthcare carries a Zacks Rank #3 (Hold). Better-ranked stocks in the hospital industry that look attractive at current levels include Acadia Healthcare Company, Inc. (ACHC), HCA Holdings, Inc. (HCA) and Lifepoint Hospitals Inc. (LPNT). While Acadia and HCA Holdings sport a Zacks Rank #1 (Strong Buy), Lifepoint carries a Zacks Rank #2 (Buy).

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