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On Dec 17, 2013, we downgraded health care services company, Tenet Healthcare Corp. (THC - Analyst Report), to Underperform based on the company’s mixed third quarter results and the lack of significant revision in estimates.

Why the Downgrade?

Estimates for Tenet Healthcare have been almost constant ever since the company reported preliminary third quarter results on Nov 4, 2013, due to lack of any significant catalyst that would spur growth.

Tenet Healthcare’s third quarter earnings per share (EPS) of 45 cents although up year-over-year, missed the Zacks Consensus Estimate of 46 cents per share, thus representing a negative surprise of 2.17%. In fact, Tenet Healthcare had reported a negative earnings surprise in three of the last four quarters, representing an average of 3.33%. Moreover, the Zacks Consensus Estimate for the fourth quarter of 2013 also represents a year-over-year decline of 28.25% to 37 cents per share.

Cause for Concern

Tenet Healthcare, with a Zacks Rank #4 (Sell), stated that a soft inpatient volume growth trend and less attractive payer mix will persist through the fourth quarter, thereby affecting financials adversely.

Tenet Healthcare serves a large number of uninsured and underinsured patients with a high burden of co-payments and deductibles, leading to an increase in the company’s provision for doubtful debts. Tenet Healthcare expects a high level of uncollectible accounts in the upcoming quarters as well.
 
An added concern is the company’s escalated level of operating expenses led by the industry-wide and company-specific challenges, including decreased volumes and demand for inpatient cardiac procedures along with high levels of bad debt. Until physician employment is streamlined and patient admissions increase, there would be no improvement in the scenario.

Overall revenues of the company face significant amounts of threat from the waning levels of inpatient revenues, due to lower adjusted admissions. The soft volume environment is expected to persist and pose a greater challenge in the upcoming quarters.

In terms of financial position, the company is burdened with huge debts, leading to a deteriorating debt-to-equity ratio thereby amplifying the financial risk. Also, legal hassles lead the company to shell out millions of dollars from time to time, weighing on the financials and affecting the goodwill of the company.

Healthcare Stocks That Warrant a Look

While we prefer to avoid Tenet Healthcare until we see signs of improvement in the company's performance, some better-ranked healthcare stocks worth a look are VCA Antech Inc. (WOOF - Snapshot Report), Acadia Healthcare Company, Inc. (ACHC - Snapshot Report) and Addus HomeCare Corporation (ADUS - Snapshot Report)  While Addus and Acadia carry a Zacks Rank #1 (Strong Buy), VCA Antech carries a Zacks Rank #2 (Buy).

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