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Hospital Industry Outlook: Demography, Consolidation Act As Tailwinds

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The Zacks Medical-Hospital industry comprises for-profit hospital companies that provide healthcare facilities through different types of hospitals such as acute care, rehabilitation and psychiatric.

The industry participants are engaged in internal medicine, general surgery, cardiology, oncology, neurosurgery, orthopedics and obstetrics, mental health care, diagnostic, and emergency services among others.

Hospital companies receive payments for patient services from the federal government under the Medicare program, state governments under their respective Medicaid or similar programs, managed care plans (including plans offered through the American Health Benefit Exchanges), private insurers and directly from patients.

Let us take a look at the industry’s three major themes:

•    According to the U.S. Census Bureau, in 2017, Americans aged 65 or older, who now comprise approximately 15.6% of the total U.S. population, are expected to increase to 19.3% in 2030. Also, due to the anticipated increasing life expectancy of Americans, the number of people aged 85 years and older is likely to increase from 6 million in 2015 to 9 million by the year 2030. This expected increase in life expectancy will spur demand for healthcare services and innovative, more-sophisticated means of delivering those services. Hospitals, as the largest category of care in the healthcare market, will be among those impacted most directly by this rise in demand.  Moreover, increase in healthcare expenditure will fuel demand for hospital services. Per CMS, in 2018, hospital care expenditures are projected to have grown 5.1%, amounting to nearly $1.2 trillion. It further estimates hospital services category expenditures to total nearly $1.3 trillion in 2019 and projects average growth of 5.7% annually for it from 2019 through 2026.  This growth is expected to continue in the coming years on a surge in healthcare spending, which is estimated to grow 5.5% in 2019 and 2020, and at an average annual rate of 5.7% from 2021 to 2026.

•    Consolidation activity in the hospital industry, primarily through mergers and acquisitions involving both for-profit and not-for-profit hospital systems, is continuing. This wave of consolidation is backed by ample supply of available capital, attractive valuation levels, the desire to enhance the local availability of healthcare in the community, the need to recruit primary care physicians and specialists, the need to achieve general economies of scale and to gain access to standardized and centralized functions, and changes to healthcare models that emphasize cost-effective delivery of service and quality of outcomes for an entire episode of care and regulatory changes.

•    However, the industry continues to face shortage of labor specially relating to nurses. A decline in the number of nurses has led to an increase in hospital readmissions and stretches the length of stay, which has a negative impact on companies. In order to better face the nursing shortage, which is expected to persist through 2025 (according to the Bureau of Labor Statistics), companies are designing their employee benefits to attract and retain nurses. In spite of this, players are likely to feel financial pain, as turnover among nurses remains high and there are not enough new nurses entering the workforce. It should be noted that salaries and benefits constitute nearly 50% of the total operating expense for the industry.

Zacks Industry Rank Indicates Bright Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates a bright near term. The Zacks Medical-Hospital industry, which is housed within the broader Zacks  Medical sector, currently carries a Zacks Industry Rank #26, which places it in the top 26% 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.

The industry’s position in the top 26% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. Since November 2018, the industry’s earnings estimate for the current year has gone up by approximately 2%.

Given the industry’s bright near-term view, we will present a hospital stock that one can invest in and a few others that could be retained in the portfolio. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Beats on Stock Market Performance

The Zacks Medical-Hospital industry has outperformed the broader Zacks Medical sector as well as the Zacks S&P 500 composite over the past year.
Over this period, the industry has gained 13% versus the broader sector’s rise of just 0.3% and the S&P 500’s growth of 10%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month EV to EBITDA ratio, which is commonly used for valuing hospital stocks, the industry trades at 9.4X versus the S&P 500’s 10.6X and the sector’s 9.5X

Over the past five years, the industry has traded as high as 12.9X, as low as 6.4X and at the median of 8.5X, as the chart below shows.



Bottom Line

Focus on expanding footprint and product portfolio through acquisitions, along with cost-saving initiatives, are expected to drive the industry’s growth. Efforts on the part of hospital companies to expand healthcare network to provide convenience and choices to patients, should drive admissions. Investments in technology will increase the efficiency of operations, thus leading to superior care at lower costs, which should benefit all sections of the industry.

However, rising labor costs from shortage of nurses and skilled workforce are weighing on the industry’s labor expense and will continue to do so.
One of the stocks in the Zacks Medical-Hospital space currently sports a Zacks Rank #1 (Strong Buy). We also present three stocks with a Zacks Rank #3 (Hold) that investors may want to hold on to for the time being.

You can see the complete list of today’s Zacks #1 Rank stocks here.

HCA Healthcare, Inc. (HCA - Free Report) : This, Nashville, TN-based hospital operates a network of acute care hospitals, outpatient facilities, clinics and other patient care delivery settings. The Zacks Consensus Estimate for 2019 and 2020 EPS indicates year-over-year growth of 3.2% and 1.6%, respectively. The stock carries a Zacks Rank #1.

Universal Health Services, Inc. (UHS - Free Report) : This King of Prussia, PA-based hospital company operates behavioral health facilities, acute care hospitals and ambulatory centers throughout the United States, the United Kingdom and Puerto Rico. The company reported better-than-expected earnings in three of the past four quarters, with the average being 2.59%.

Acadia Healthcare Company, Inc. (ACHC - Free Report) : This Franklin, TN-based hospital provides inpatient behavioral health care services. It offers psychiatric and chemical dependency services, including inpatient psychiatric hospitals, residential treatment centers, outpatient clinics and therapeutic school-based programs, The consensus estimate for 2019 and 2020 earnings indicates year-over-year growth of 0.5% and 0.4%, respectively.

Tenet Healthcare Corp. (THC - Free Report) : This Dallas, TX-based company provides technology-enabled performance improvement and health management solutions to hospitals, health systems, integrated delivery networks, physician groups, self-insured organizations and health plans.

The consensus estimate for 2019 earnings indicates year-over-year growth of 5%.

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