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Hospital Industry Outlook: Solid Fundamentals Promise Growth

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Increasing baby boomer population, diminishing unemployment, higher disposable income, economic strength, rising prevalence of chronic disease and increase in insured population are the catalysts that have been driving demand for hospitals sector services.

Nevertheless, a rise in high deductible insurance plans, growing efforts to reduce unnecessary hospitalization, greater use of chronic disease management programs and a shift toward outpatient treatment are partial dampeners to the industry’s growth.

Hospitals stand to gain as both large and small employers have been offering richer health benefits due to a tight labor market. Surgery trends and inpatient surgeries have also been on a rise led by greater propensity of patients to spend more, thanks to increased employment and wage gains.

Solid capital deployment opportunities from tax reform provides a conducible backdrop for multiple expansion and merger and acquisition opportunities

Outstanding Industry Returns

Increasing patient volumes along with declining bad debts due to an increase in the population having insurance have aided revenues and margins of players. Strong capital levels across the industry have enable disciplined capital management via share buyback and dividend payouts that have garnered investor attention.

The Zacks Medical-Hospital industry, which is a stock group within the broader Zacks Medical Sector, has outperformed both the S&P 500 and its own sector over the past year.

We see that the stocks in this industry have collectively gained 39.4% over the past year, while the Zacks S&P 500 Composite and Zacks Medical Sector have rallied 15.1% and 5.3%, respectively.

One-Year Price Performance

Attractive Valuation

Despite remaining an outperformer in the past year, the industry remains attractively valued. We look at the industry’s EV/EBITDA ratio, a suitable measure for valuing the hospital industry.

The industry currently has a trailing 12-month EV/EBITDA ratio of 8.39X, which is higher than its median level of 7.64X, and at its highest range. Though it is trading at its highest level, a comparison of the group’s EV/EBITDA ratio with that of its border sector shows that the group is trading at a decent discount.

The Zacks Medical Sector’s trailing 12-month EV/EBITDA ratio of 10.32X and the median level of 10.19X for the same period are above the Zacks Hospital Industry’s respective ratios.

EV/EBITDA Ratio (TTM)

The space also looks inexpensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.19X and the median level is 11.38X.

EV/EBITDA Ratio (TTM)


Outperformance to be Driven by Solid Earnings Oulook

Increasing demand for hospital services from an aging U.S. population should lead to an increase in revenues. Moreover, increasing employment will also drive employers’ demand for insurance for their employees, which will help bad debts. Cost control efforts, measures at providing efficient care at lower cost — should help to keep a check on medical care cost, thus aiding margins.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The earlier valuation discussion shows that market participants have been willing to pay up for these stocks already, potentially limiting further upside from the current levels.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revision trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations from it and the aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Zacks Medical Hospital Industry

This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $5.52 EPS estimate for the industry for 2018 is not the actual bottom-up EPS estimate for every company within the Zacks Hospital industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry’s earnings for 2018 but how this estimate has evolved recently.

Current Fiscal Year EPS Estimate Revisions 

The consensus earnings estimate for the Zacks Hospital industry of $5.52 per share implies a decent year-over-year improvement (up 8.4%), the trend in earnings estimate revisions has also been favorable.

Looking at the aggregate earnings estimate revisions, it appears that analysts’ confidence in this group’s earnings potential is building up.

The consensus EPS estimate for the current fiscal year has been revised 2.6% upward since May 30, 2018.

Zacks Industry Rank Indicates Improvement

The group’s Zacks Industry Rank is basically the average of the Zacks Rank of all-member stocks.

The Zacks Medical Hospital Industry currently carries a Zacks Industry Rank #19, placing it at the top 7% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Hospitals Promise Long-Term Growth

The long-term prospects for the industry are bright. When compared with the broader Zacks S&P 500 composite, the long-term (3-5 years) EPS growth estimate for the Zacks Hospital Insurance industry appears promising.

The group’s mean estimate of long-term EPS growth rate after increasing since December 2017, when it was 8.46%, has stabilized at 13.02% since May 2018. The same compares favorably with 9.8% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

In fact, the basis of this long-terms EPS growth could be the recovery in top line that hospitals ave been showing since the beginning of 2013.

Bottom Line

The ageing American population along with increased life expectancy will continue to drive demand for hospital services.

Players in the industry are making investments in health technologies and are working to harness the power of big data to efficiently test methodologies, discover trends and provide information to support their physicians and clinicians in their continuous strive to improve the quality of care to their patients. This should ultimately lead to lower cost and higher patient admissions thus aiding both revenues and margins.

Regulatory burdens imposed by healthcare reform initiatives are making healthcare providers pursue strategic acquisitions and partnerships. M&A has been one of the most sought after route to create operational, strategic, and financial value, over the past many years. Numerous mergers and acquisitions have lead to economies of scale, placing the industry to efficiently manage costs and improve productivity and outcomes through higher business volumes. This consolidation paves the way for long-term growth.

The Tax Cuts and Jobs Act has reduced the tax payments for the industry. Savings from this is being reinvested in markets and workforce development, which should drive long-term growth.

Therefore keeping long-term projections in mind, investors could take advantage of the attractive valuation and bet on a few hospital industry stocks with a strong earnings outlook.

Below are four stocks with positive earnings estimate revisions and a bullish Zacks Rank. (You can see the complete list of today’s Zacks #1 Rank stocks here.)

LifePoint Health, Inc. (LPNT - Free Report) provides quality inpatient, outpatient and post-acute services close to home. LifePoint owns and operates community hospitals, regional health systems, physician practices, outpatient centers, and post-acute facilities.

The company has a Zacks Rank #2 (Buy). The expected earnings growth rate for the current year is 25%. The Zacks Consensus Estimate for the current year has improved 5.8% over the last 30 days.

HCA Healthcare, Inc. (HCA - Free Report) is a non-governmental hospital in the U.S. providing health care and related services. The company operates a network of acute care hospitals, outpatient facilities, clinics and other patient care delivery settings.

The company has a Zacks Rank #1 (Strong Buy). The expected earnings growth rate for the current year is 5.85%. The Zacks Consensus Estimate for the current year has improved 4.5% over the last 30 days.

UnitedHealth Services, Inc. (UHS - Free Report) is one of the nation's largest and most respected healthcare management companies, operating through its subsidiaries, behavioral health facilities, acute care hospitals and ambulatory centers throughout the United States, the United Kingdom and Puerto Rico.

The company has a Zacks Rank #2. The expected earnings growth rate for the current year is 26%. The Zacks Consensus Estimate for the current year has improved 0.96% over the last 30 days.

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