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Nicholas Coppola, CFA
May 8, 2020
As you may have seen in recent trade confirmations, we’ve established a new position in HCA Healthcare (HCA) in client portfolios. As a matter of background, HCA is a leading healthcare provider that owns and operates a large network of hospitals and other outpatient facilities, including physician offices, urgent cares and freestanding surgery centers. The company has a presence primarily in twenty-one states across the country, with their greatest concentration in Texas and Florida, which together represented almost half of revenue last year.
Over the long-term, we think the outlook for HCA remains positive based on their positioning in markets with attractive demographics (i.e., Texas and Florida) and their strong and improving local market share. In our view, HCA’s revenue going forward will be driven by population growth and share gains driving higher inpatient and outpatient volumes, as well as changes to their payer mix, pricing and acquisitions. Over the long-term, we also think their EPS should grow somewhat faster than revenue, based on potential margin expansion and additional share repurchases, which we expect to resume after headwinds from COVID-19 abate. Importantly, we think HCA is a well-run company and their quality of care and profitability metrics compare favorably to hospital peers, including the many non-profit and government-run facilities in the industry. In our view, this performance has been enabled at least in part by their scale and savvy use of data analytics, which contributes to the sharing of best practices across the company. And in terms of the competitive environment, we think barriers to entry are fairly high. Note that in order to start a new hospital or expand a facility, many states require a ‘Certificate of Need’ (CON) to be approved. In our view, based on HCA’s geographic exposure and competitive positioning, the company should continue to generate attractive long-term returns on invested capital, which over the last ten years have averaged in the mid-teens.
However, there are also a number of risks to our investment thesis, with many of them driven by politics, which is often difficult to predict. And while we think ‘Medicare for All’ is unlikely, noise around healthcare policy leading up to the presidential election, including price transparency initiatives, could negatively impact short-term performance. And while public options that expand coverage to more Americans can be good news for healthcare providers, it can also be a substantial negative if it detracts from higher paying commercially insured patients. And in regards to COVID-19, the virus has been a significant headwind as elective surgeries are deferred and many patients look to avoid hospitals altogether. At the same time, we think this should simply lead to pent-up demand that will be released when virus fears abate. Additionally, while the healthcare industry is often viewed as a sector that is less sensitive to the economy, as the unemployment rate rises, there could be a significant change to their payer mix, with more patients shifting from employer sponsored coverage to less profitable payer types. Similarly, we expect this headwind to be temporary.
More importantly, we think the long-term outlook for the business remains positive and the current stock price more than bakes in the aforementioned risks. Note that the stock has sold off ~30% year-to-date and is now trading at just ~10.5x trailing twelve months earnings. This compares to the S&P 500 which has sold-off ~10% year-to-date and is trading at ~19.8x trailing twelve months earnings. All in, we think the recent sell-off in HCA has created an attractive buying opportunity and the risk/reward profile skews to the positive.
We thank you again for your continued trust. As always, please let us know if you have any questions regarding recent trades or your broader portfolio.
Nicholas Coppola, CFA
Senior Portfolio Manager