During tough times, one area that you might think stable would be the healthcare space. After all, the industry solves problems that we all encounter from time to time, essentially creating a permanent level of demand that should exist. But just like any other industry in the economy that has grown to significant size, the healthcare space is more complicated than that. In the end, it’s not just about the revenue that can be generated. Profits are also important, and these can change significantly depending on market conditions. A company that makes a good showing on this front is Universal health services (New York stock market :UHS), a company that owns and operates various healthcare facilities. Generally speaking, I’ve been quite optimistic about universal health services, but the most recent picture has been somewhat mixed. Revenue continues to rise, but declining profits have become a problem. Even with that, however, the patient investor should find plenty to like about the company. The growth continues and the company’s shares are trading at fundamentally cheap levels. So while the company is having its issues right now, I think it still deserves a strong Buy rating, which reflects my belief that it should outperform the market for the foreseeable future.
Patience is required
At the beginning of March of this year, I wrote a article detailing the investment value of universal health services. In this article, I found myself encouraged by the company’s growth in revenue and cash flow. Even then, I had concluded that, from a profitability perspective, fiscal 2022 could be somewhat challenging for the company. But overall, I felt the stocks were cheap enough to warrant a move up in the future. This led me to keep the company a “buy” as I had previously rated it. Since then, however, actions have not worked out exactly as I would have expected. While the S&P 500 is down 6.1%, shares of Universal Health Services generated a loss for investors of 16%.
When I last wrote about the company, we had data covering fiscal year 2021. Fast forward to today, and we now have data covering the entire first three quarters of 2022. During this time, many things have happened. For the first nine months of fiscal 2022 in full, revenue was $9.95 billion. This is 6.2% more than the $9.37 billion generated a year earlier. This increase is largely explained by two different factors. Most significant was a $400 million increase in net revenue from its acute care hospital services and behavioral health services businesses. According to management, this increase is due to various factors, including a 1% increase in net revenue per adjusted admission and a 2.6% increase per adjusted patient day. The company also benefited from a $186 million increase caused by other miscellaneous factors that it did not disclose.
With the increase in revenue, you might think that the business needed to increase its profitability as well. Unfortunately, you would be wrong. Net profit for the first nine months of this year totaled $500.8 million. That’s down from the $752.5 million reported a year earlier. Ultimately, there were two key factors behind the decline in earnings. The first of these was an increase in salaries, wages and benefits, from 48.5% of sales to 50.9%. The second was an increase in other operating expenses from 23.8% of sales to 25.4%. Clearly, inflationary pressures had a negative effect on the company. Other profitability indicators have unfortunately followed suit. Although cash flow from operations increased from $561.7 million to $698.7 million, the corresponding adjusted figure, which excludes changes in working capital, increased from $1.23 billion. dollars to $983.4 million. Meanwhile, the company’s EBITDA also deteriorated from $1.45 billion to $1.19 billion.
Ideally, the company should see these issues diminish over time. But so far this has not happened. Take the third quarter of fiscal 2022 all by itself. Again, revenue is higher year over year, having increased 5.7% from $3.16 billion to $3.34 billion. At the same time, however, profits are down. Net income fell from $218.4 million to $182.8 million. Cash flow from operations fell from $442.3 million to $220.7 million, while the figure adjusted for it fell from $388.8 million to $343.2 million. During the same period, even EBITDA deteriorated from $448.2 million to $427.8 million.
With respect to the 2022 financial year as a whole, management waits revenue is expected to be between $13.235 billion and $13.371 billion. If this materializes, it would translate to a nice increase from the $12.64 billion generated in 2021. Earnings per share, however, should be between $9.60 and $10.40. Halfway through, that would translate to a net profit of $730.6 million. Meanwhile, EBITDA is expected to be between $1.64 billion and $1.71 billion. Mid-term, this would translate to adjusted operating cash flow of approximately $1.30 billion. Taking these numbers, I calculated that the company trades at a forward price multiple of earnings of 11.9, a forward price multiple of adjusted operating cash flow of 6.7, and an EV multiple at EBITDA of 8.6. As you can see in the chart above, these are all higher than what we would get if we were valuing the company using 2021 data. Compared to similar players, however, the shares seem to be more or less fairly assessed. On a price/earnings basis, the five companies I compared it to ranged from a low of 1.8 to a high of 26. Using the price/operating cash flow approach, the range was between 3.6 and 20.2. In both cases, two of the five were cheaper than universal health services. Meanwhile, using the EV to EBITDA approach, the range was between 6.7 and 15.5, with three out of five companies being cheaper than our target.
|Company||Price/Benefit||Price/Operating Cash Flow||EV/EBITDA|
|Universal health services||11.9||6.7||8.6|
|HCA Health (HCA)||12.7||8.0||8.3|
|Ensign Group (ENSG)||25.7||17.7||14.8|
|Acadia Health Care Company (CCSA)||26.0||20.2||15.5|
|Health Care Principle (THC)||8.6||4.7||6.7|
|Community health systems (CYH)||1.8||3.6||7.7|
Clear Lake, the past few months have not been particularly good for Universal Health Services shareholders. Rising costs more than offset rising revenues. In the short term, this is problematic, but it is unclear what the end result will be. Even if this problem persists, however, the stock appears to be attractively priced on an absolute basis, although it could be closer to fair value compared to similar players. Given these prices and continued revenue growth, I still think the company deserves a ‘buy’ rating, although I’m not quite as optimistic about it as when I last wrote this. topic.