Smart Investing

 

June 29, 2012

October 25, 2013


Checking vital signs on health care stocks

On Thursday, the Supreme Court ruled to uphold the Affordable Care Act, and the law will continue to move forward for now.

If former Massachusetts Gov. Mitt Romney is elected to be the next president, he has vowed to reverse course on health care. Since it has now been considered a tax, it can be challenged in court. However, the tax must be paid before it can be disputed, which pushes the issue out to 2014.

When the Supreme Court announced the decision, heath care stocks rallied. Did you jump in and buy one of these health care companies?

Or, are you still reading and analyzing the financial statements? If you are, let me give you a second opinion on what I see on one of the companies in this area: HCA Holdings Inc.

HCA is one of the big ones. It trades under the symbol HCA and has a market cap of around $13 billion. HCA operates hospitals, surgery centers, diagnostic and imaging centers, and more. The company operates 163 hospitals, five psychiatric hospitals and 108 surgery centers in 20 states. The company, founded in 1968, is based in Nashville, Tenn., and employs 150,000.

Based on the financial statements, HCA looks pretty good in the beginning; the company has a current PE of 4.5, well below the industry average of 20.9. The forward PE is higher at 7.7, based on the mean of $3.76 of 22 analysts.

Price to sales looks good as well, coming in at 0.35, which is not quite one-third of the industry average of 0.93. Price to cash flow also looks good at 2.5 compared to the industry average of 8.7.

A big problem is that there is no price-to-book value. Why? The company's assets are $27 billion, but liabilities are $36 billion, which means the company has a negative equity of nearly $9 billion. This is like being upside-down on your mortgage — not a good position to be in.

Revenue has climbed 7.9 percent year over year, which is not too bad. However, the industry did grow revenue at a 13 percent rate year over year. When it came to earnings-per-share growth, the industry did a have a problem, seeing its growth decline by 12.4 percent year over year while, in the meantime, HCA experienced an earnings-per-share growth of 147 percent year over year.

Looking at the income statement, I discovered a $145 million gain on assets and unusual income of $1.5 billion in the fourth quarter of 2011. This inflated the EPS for the fourth quarter to $4.25 — 2010 fourth-quarter EPS was only 65 cents. The problem here is this will not be recurring and distorts the current PE and the earnings growth. This is a trap investors must be careful not to fall into.

With no equity, the financial strength of HCA is questionable. It has a current ratio of 1.3, which is OK, but below the industry average of 1.52. An important ratio for me is the debt-to-equity ratio, which HCA doesn’t have, because it has no equity. But potential investors should be aware that the company does carry nearly $28 billion in debt on the balance sheet, which is up about $2.4 billion from one year ago. It should also be noted that goodwill is now $5.4 billion, up from $2.7 billion one year ago.

Net profit margin looks good at 9.35 percent compared to the industry average of 4.5. But remember, that $1.5 billion and $145 million in non-operating income, which would be a big boast in the net profit margin over the last 12 months, won’t be there over the next 12 months, and the profit margin will fall back down to normal levels. This would also affect return on equity, but because HCA has no equity, there is no return.

Receivable turnover looks good at 7.5, just under the industry average of 7.6.

Inventory turnover does not look good for HCA, coming in at 5.5, while the health care facilities industry was nearly three times higher at 14.9.

Investors will collect no dividend from HCA, which is smart on the company side; it needs to work on paying down its $28 billion in debt. If investors are looking for a company that has good earnings and hope that Obamacare works, they will be tempted by HCA.

I would have to raise a flag of caution and encourage investors to look at the balance sheet, which is the foundation for any company, and realize that the risk here is high. Be careful if you own this company in your portfolio.

Have a question or a company you'd like me to take a look at? Email me at brent@wilseyassetmanagement.com.

















Wilsey is president of Wilsey Asset Management and can be heard every Saturday at 8 a.m. on KFMB AM760. Information is provided by Reuters.


 

June 29, 2012

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