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On April 3, 2014, we issued an updated research report on Tenet Healthcare Corp. (THC - Analyst Report). The company has been witnessing intense inpatient volume pressure and increased expenses for quite some time. These headwinds are expected to persist in the near term, thereby weighing on the positive impact of improved outpatient revenues and inorganic growth.

Earlier, Tenet Healthcare reported fourth-quarter 2013 earnings that surpassed the Zacks Consensus Estimate. However, earnings failed to comply with the year-ago number due to dismal inpatient volumes. With expected inpatient volume trends of (2%)–0% in 2014, inpatient operations and revenues are expected to remain under pressure. However, this Zacks Rank #5 (Strong Sell) healthcare services company delivered positive surprises in two of the last four quarters, with an average beat of 9.45%.

Apart from weak inpatient volumes, high bad debts due to a huge client base of uninsured and underinsured patients, and a high burden of co-payments and deductibles, are matters of concern. Apart from burgeoning bad debt levels, the impact of industry-wide and company-specific challenges has led operating expenses to increase significantly. For 2014 also, this trend is expected to continue reflecting an increase in selected operating expenses for Tenet Healthcare’s hospital operations on an adjusted admission basis by 1.5–2.5% for 2014.

Moreover, Tenet Healthcare is a highly leveraged company. Substantial long-term debts and deteriorating debt to equity ratio reflects the financial risks of the company. In fact, Tenet Healthcare deploys a substantial part of its cash flow to pay interests on debts and thus is left with limited funds for operations, growth initiatives or capital expenditures. Legal hassles have also drained out cash, weighing on expenses and affecting the goodwill of the company.

On a brighter note, growth in operating revenues has been impressive over the past few years and 2013 witnessed a significant 21.7% increase. The California Provider Fee program is proving beneficial in this regard and Tenet Healthcare is expected to record revenues worth $475 million from this program through 2016. While inpatient revenues remained pressed, outpatient business has generated significant margins.  

We also remain content about the mergers and acquisitions undertaken by the company over the last two years. These inorganic growth strategies helped the company strengthen its operations as well as expand geographically. Notably, the Vanguard Health Systems acquisition in Oct 2013 is expected to boost company earnings, especially from the second half of 2014.

Tenet Healthcare also stands out in its remarkable capital deployment initiatives. Further, given the concentration of the company’s operations in California, Florida and Texas, which historically have high percentages of uninsured and underinsured patients, Tenet Healthcare enjoys a strong competitive advantage from extended insurance coverage.

Other Stocks to Consider

Aetna Inc. (AET - Analyst Report), Chemed Corp. (CHE - Snapshot Report) and MEDNAX, Inc. (MD - Snapshot Report) are some better-ranked stocks in the healthcare services space. While Chemed sports a Zacks Rank #1 (Strong Buy), Aetna and MEDNAX carry a Zacks Rank #2 (Buy).

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