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Tenet Downgraded to Neutral

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We have downgraded our recommendation on Tenet Healthcare Corp. (THC - Free Report) to Neutral from Outperform based on its rising expenses and bad debts coupled with a highly leveraged balance sheet.

However, strong organic and inorganic growth and strategic plans to optimize capital structure are the positives.

Tenet Healthcare is scheduled to announce its third quarter results on November 7 before the bell. The Zacks Consensus Estimate for the quarter is currently pegged at 36 cents, reflecting a 126.7% year over year improvement.

Tenet Healthcare has been generating consistent growth in operating revenues since 2006. The first half of 2012 also witnessed operating revenue growth of 4.2% year over year to $4.57 billion. The improved results were attributable to significant contribution from Tenet Healthcare’s general hospitals, which have generated revenues in excess of 96% of the net operating revenues for all periods.

Tenet Healthcare has also been steadily expanding its operating capacity via acquisitions and alliances. Moreover, the company is trying to enhance business growth and optimize its capital structure through financial and strategic plans comprising acquisitions, share repurchases, debt repayment and a reverse stock split. While the acquisitions will be directed toward strengthening the company’s main business lines, the planned share buyback will enhance earnings per share and boost shareholder value.

However, Tenet Healthcare is a highly leveraged company with approximately $4.51 billion long-term debt as of June 30, 2012, compared with shareholders’ equity of only $1.18 billion. This implies a long-term debt-to-equity ratio of 3.88.

Moreover, 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, due to which Tenet Healthcare has been increasing the provision for doubtful debts.

Furthermore, Tenet Healthcare is experiencing high levels of operating expenses over the past few years. The impact of industry-wide and company-specific challenges, including decreased volumes and demand for inpatient cardiac procedures along with high levels of bad debt, has led to the rise of operating expenses.

Tenet Healthcare competes with Universal Health Services Inc. (UHS - Free Report) and HCA Holdings, Inc. (HCA - Free Report) .

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