3 hospital stocks for a healthy portfolio

If Obamacare thrives or gets thrashed, these names should prosper.

By InvestorPlace May 25, 2012 10:04AM

By Susan Aluise


Investors have been getting a lot of mixed messages about hospitals lately. But one thing is certain: Chains that make healthier business choices today will be more likely to deliver better outcomes for investors tomorrow. Cutting costs and boosting operational efficiency will go a long way toward healing the sector's ills in the short term.


Some analysts are bullish because they believe President Barack Obama's health care reform law will stem losses from uninsured patients. Glenview Capital founder Larry Robbins told the Ira Sohn hedge fund conference earlier this month that he's long hospitals because the landmark Affordable Care Act requires virtually all individuals to obtain health insurance or face a fine.


In particular, Robbins is bullish on Tenet Healthcare (THC). Because uninsured patients often receive uncompensated care in hospital emergency rooms, Obamacare's universal mandate will ease that burden, proponents say. Robbins also noted that the sector is trading at a 21% discount -- an added perk for value investors.


Bears, however, fear a long, gloomy road of reduced federal and state government spending -- noting that the pain likely will be felt in Medicare cuts later this year. In January, Citigroup analyst Gary Taylor downgraded four hospital stocks to "sell:" Tenet, Sun Healthcare (SUNH), Lincare Holdings (LNCR) and AMN Healthcare (AHS). Taylor downgraded four other stocks from buy to hold: HCA Holdings (HCA), Health Management Associates (HMA), LifePoint Hospitals (LPNT) and Universal Health Services (UHS).


"Federal and state governments are still deficit-challenged and just beginning a cycle of spending cuts," he said.


Another potential challenge for the hospital sector: It's impossible to predict whether the Supreme Court will strike down the ACA next month, or exactly how the law could change if it survives its Constitutional test.


In an industry that favors second opinions, the high court's diagnosis is highly anticipated, to say the least. Still, the hospitals that are most effective in cutting costs, doing more with less and keeping their own business strong will better survive the sector's near-term transition -- and deliver more value to shareholders over the long haul.


Here are three hospital stocks -- one of the largest chains, a rural chain and a specialty chain -- I think can help keep your portfolio healthy:


HCA Holdings

A little more than a year after its IPO, the Nashville-based, 163-hospital chain is looking pretty good. Patient volumes are growing, same-facility equivalent admissions (a measurement similar to same-store sales in the retail sector) rose 3.2% last quarter and earnings soared.


Earlier this month, HCA reported first-quarter 2012 earnings of $1.18 a share on revenue of $8.4 billion -- a 91% increase over the same quarter last year. Wall Street analysts had estimated earnings of 94 cents a share on nearly $8.8 billion in revenue.


HCA Chairman and CEO Richard Bracken attributed the growth to "effective cost management and continued focus on our quality and patient service agendas." Although HCA's surgical admissions are down, the chain is expanding operating room space and investing in technology to help reverse that decline.


HCA is trading around $26 -- 52% above its 52-week low last fall. It has a price-to-earnings to growth ratio of 0.6, indicating that it is undervalued, and a forward price-to-earnings ratio of only 7, which favorably compares to the industry average of about 11.


I think HCA is doing a good job of holding the line on costs, while making focused investments to increase surgical admissions. I consider HCA a buy, with a price target of $30.


LifePoint Hospitals

LPNT operates a chain of 54 hospitals located in rural U.S. areas. Several acquisitions and the Duke LifePoint Healthcare partnership it formed last year are giving the chain a boost.


"The Duke LifePoint component of our acquisition strategy has been very successful with four acquisitions completed totaling approximately $200 million in revenue," Chairman and CEO William Carpenter said earlier this month.


Although same-hospital admissions fell nearly 4% in the first quarter, the chain's focus on efficiency helped earnings grow by 22%. Revenue was up by a better-than-expected 12%.


LPNT is trading around $27, 27% above its 52-week low last August. The stock has risen nearly 4% since Auriga analysts upgraded it from hold to buy on Wednesday. LifePoint has a price-to-earnings to growth ratio of 1.1, indicating it may be slightly overvalued. Its forward price-to-earnings ratio of 10 is a hair below the industry average.


LPNT is a strong player in the rural hospital market, and its acquisition strategy already is showing results in boosting economies of scale. Buy LPNT with a price target of $41.


Select Medical Holdings

Select Medical (SEM) operates 954 specialty hospitals and outpatient rehabilitation clinics in 32 states and the District of Columbia. Its inpatient division includes long-term acute care and medical rehabilitation hospitals. Its outpatient clinics focus on physical rehabilitation and therapy.


In its first-quarter earnings released earlier this month, SEM beat the Street on both the top and bottom lines. Revenue was up 7.3%, and profit rose nearly 32%. In January, it opened the new 60-bed SSM Rehabilitation Hospital on the campus of DePaul Health Center in Bridgeton, Mo.


With a market cap of $1.3 billion, SEM is trading around $9 and is 67% higher than its 52-week low last fall. It has a price-to-earnings to growth ratio of about 1, indicating it's fairly valued. It has a forward price-to-earnings ratio of about 10.


I like SEM's niche market, and I see it continuing to grow as the baby boomer population ages. I also think SEM is a buy, with a price target of $11.


As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.


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