Investment Thesis

The decision by HCA Healthcare, Inc. (HCA) to return the federal aid early highlights the improving prospects of the company. The announcement came with an upbeat preview of earnings for the previous quarter, but shares continue to underperform the broader market. Despite a quarterly rebound in revenue growth at HCA, the pandemic and political risks weigh on the sector. The resurgence of COVID-19 can once again drain the company resources. And a possible Democratic sweep in the upcoming election can lead to healthcare reforms causing sector-wide implications on returns.

Therefore, without any upgrade, the average pre-pandemic trading multiple of HCA indicates only a modest premium with our bullish EBITDA forecasts for next year. However, the return of taxpayer money upgrades the company’s corporate standing and indicates its robust liquidity. Therefore, given the renewed flexibility in capital spending to navigate the uncertainty, HCA is a ‘Hold’ for the long-term investor.

HCA Healthcare_Company Pic_1Source: Fierce Healthcare

Investors Are Unimpressed

A few days ago, HCA announced its decision to return the federal assistance early. Received as part of CARES (Coronavirus Aid, Relief, and Economic Security) act to ride out the pandemic’s impact on the company’s operations, the funds worth approximately six billion dollars would be swiftly handed back to the government, the company announced. The cash flows came under pressure at the height of the pandemic due to COVID-19 care and government-imposed restrictions on elective procedures in Q2 2020 (second quarter of 2020). Therefore, it was no surprise the company tried every possible means to shore up the liquidity as the margin-friendly elective surgeries power the revenue growth and boost the bottom-line at for-profit hospitals.

The request for federal funds had raised $4.4 billion of accelerated Medicare payments and $1.4 billion of CARES act relief funds. The grant had no repayment requirement, but the unused Medicare advances had to be repaid in full within 7-12 months. The announcement points to an improving outlook for the company as it accompanied an upbeat preview of earnings for the past quarter. Yet, the investor reaction has been lukewarm, and shares have risen only ~2.5% since then, marginally outperforming the ~1.4% gain in the IHF (iShares U.S. Healthcare Providers ETF).

HCA Healthcare_YTD PerformanceSource: Koyfin

A Rebound in Quarterly Growth…

As outpatient surgeries slumped nearly a third in Q2 2020, the top-line contracted ~12.2% YoY, but thanks to the receipt of relief funds recognized as $822 million of government stimulus income, the bottom-line grew ~37.8% to ~$1.1 billion. When Texas and Florida, accounting for more than half of the hospital network’s beds and ~48% of the company revenue, witnessed a resurgence of the pandemic in July and August, the company was bracing for the worst in the third quarter. Yet, with no government-imposed limits, the surgery volumes dropped only ~9% YoY, and with a favorable revenue mix offsetting the decline, the top-line has jumped ~4.8% YoY, recording the best quarterly revenue growth for the year. In terms of payer mix, the commercial business has represented 24% of total admissions compared to 23% in the previous year, and despite a slump in inpatient volumes, the overall acuity has risen 8% from the previous year, up from 3% in the quarter before.

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…Warrants an Optimistic Revenue Forecast

Having fulfilled only 50-60% deferred cases in the outpatient area as of mid-September, the company has many more procedures lined up to power the growth. The current resurgence of the pandemic is unlikely to block the revenue benefit as the company remains well-prepared to address a surge in COVID-19 cases. Moreover, the case counts in Texas and Florida have dropped in recent weeks, and absent the demand pressure, a resource drain at hospitals is unlikely. Meanwhile, the company is confident in the recovery of the majority of deferred cases in the coming months, but the new cases, however, will not have the same level of acuity as the previous ones; consequently, the top-line benefit could wane early.

The current Wall Street forecast for HCA stands at ~$50.7 billion of revenue for 2020, and with ~$13.3 billion of revenue as announced by the management for the previous quarter, the consensus forecast implies a contraction of ~0.5% YoY in Q4 2020. With the company returning to growth momentum and being well-equipped to fight the pandemic, we expect the revenue to grow ~6.0-6.3% in the final quarter. The overall growth of ~0.4-0.5% YoY for the year could generate ~$51.5-51.6 billion of revenue, ~3.7-7.0% short of the now-withdrawn pre-pandemic revenue guidance. Assuming a return to normalcy next year with a possible discovery of a vaccine, and given the lower base in the current year, we optimistically forecast ~$56.6-56.9 billion of revenue for 2020, a growth of ~9.8-10.3% YoY, mostly in line with ~10.0% YoY growth seen in 2019.

No Benefit to Margins When Favorable Revenue Mix Wanes

From ~18.8-19.1% in 2017-2019, HCA’s EBITDA margin has dipped to ~16.9% in the first half of 2020 (H1 2020) as profitable elective surgeries came to a halt. However, thanks to the government stimulus income, the adjusted EBITDA margin improved to ~24.1% in Q2 2020, up from ~18.9-19.2% in 2017-19. And the reversal of the benefit in the previous quarter has narrowed the margin to ~15.3%. Even excluding the one-off impact, our calculation indicates that the adjusted EBITDA margin for Q3 2020 has climbed to ~21.4% in Q3 2020, up from 10.9% in the prior quarter as profitable procedures picked up.

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Compared to ~21.8% implied by the consensus EBITDA forecast for 2020, considering the historical data, we believe HCA’s EBITDA margins for H2 2020 could only reach ~20.5-20.8%, up from ~16.9% in H1 2020. The ~18.6-19.0% of EBITDA margin for the full year, generating ~$9.6-9.8 billion, will narrow to an estimated ~18.4-18.8% next year, bringing ~$10.4-10.7 billion of EBITDA as the benefit of favorable revenue mix tails off.

Return of Funds Indicates Extent of Liquidity

HCA’s decision to return federal funds early follow those taken by Encompass Health Corporation (EHC) and DaVita Inc. (DVA). All three healthcare providers, with stronger balance sheets and low gearing, are better positioned to withstand the pandemic’s impact compared to highly-geared recipients such as Tenet Healthcare Corporation (THC). Therefore, the early return of taxpayer money indicates more about the extent of the liquidity than their corporate social liquidity.

HCA Healthcare_Gearing Source: Koyfin

Following the issuance of ~$2.7 billion of notes in February 2020, HCA had ~$4.6 billion of cash and equivalents as of the end of Q2 2020, more than a sevenfold rise from 2019 year-end. That was on top of ~$7.7 billion of borrowing capacity available at the time. Despite the pandemic’s impact on the top-line, the second-quarter operating cash flow, excluding the federal funds worth ~$5.8 billion, has climbed nearly a half from the previous year. Now that the company is swiftly returning the taxpayer money, its finances will not come under close public scrutiny, enabling the company to chart a more flexible approach to capital spending and lift the suspension of share buybacks and dividends.

Ongoing Risks Cloud the Prospects

Yet, the optimistic outlook hasn’t piqued investor interest as the shares trade 8.3% below the level at the start of the year. The concerns over the twin impact of the pandemic and political uncertainty have seemingly weighed, not only on HCA, but the entire sector. Gaining only ~7.2% for the year so far, IHF has yet to outperform the ~9.5% rise in the SPY (SPDR S&P 500 ETF).

Despite the recent slump in new cases in Texas and Florida, the future course and severity of the pandemic are hard to predict without an approved vaccine against COVID-19 widely available. The virus is resurging in the U.S., and the epidemiologists fear a winter wave of new cases. A possible fresh influx of hospitalizations could once again put healthcare resources under strain. Last week, the country’s COVID-19 hospitalizations reached its highest since the August peak. It was only last month HCA’s CFO highlighted the continuing supply-side pressure for PPE.

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The political risks only add to the uncertainty. With the odds favoring a Biden win in the upcoming presidential election, the reforms to the Affordable Care Act appear ever more likely. The proposal to reduce the Medicare age from 65 to 60 could increase the patient volumes, but a concurrent shift from commercial payer will be negative for the sector as the lower reimbursement rates from state-backed insurance can hurt the bottom-line. Add the impact of Democrat’s proposal for higher taxes, a possible blue sweep in the Congress can send shockwaves across the sector.

HCA Healthcare_NTM EV - EBITDA_2019 AverageSource:

With No Upgrade, The Historic Multiple Indicates a Modest Upside

Underscoring those concerns, HCA had only risen ~20.2% in 2019, underperforming the ~22.3% gain in the IHF, and the NTM EV/EBITDA multiple averaged ~8.3x ranging from ~7.6-~9.0x. Despite the rapid recovery in Q3 2020, we believe the trading multiple doesn’t warrant an upgrade as the sector outlook remains cloudy. Assuming the average trading multiple for 2019, the above EBITDA forecasts for 2021 indicate a premium of only ~9.2-14.4% for the stock, hardly a ‘Buying’ opportunity for near-term gains. But with a solid balance sheet and liquidity as indicated by the decision for the early return of federal funds, the largest hospital operator in the U.S. is a ‘Hold’ for the long-term investor.

HCA Healthcare_ValuationSource: The Author; Data from Seeking Alpha, and Author Estimates


A rebound in quarterly revenue growth at HCA has followed up with a decision to return the federal aid early. Though it indicates the resilience of company cash flows, the sector outlook remains uncertain. The pandemic’s resurgence can strain the medical resources once again, and political risks can weigh on the sector returns. Therefore, with no upgrade, the historical average of the trading multiple with our optimistic EBITDA forecasts for next year suggests only a modest premium for the stock, hardly enough for short-term gains. With a solid balance sheet for flexible capital spending through uncertain times, HCA is, however, a ‘Hold’ for the long-term investor.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.