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Morningstar | SGRY Updated Forecasts and Estimates from 14 Nov 2018

No-moat Surgery Partners reported third-quarter results that continue to showcase the progress management has made in improving the firm's operations. A return to organic case growth, ongoing portfolio improvement efforts, and expanding profitability all help to position the firm for continued success in the years ahead. As we make small tweaks to our near-term forecast, our longer-term outlook remains unchanged, and we intend to maintain our $19 per share fair value estimate, which implies roughly 10.5 times our 2019 adjusted EBITDA forecast.

A return to same-facility volume growth was a bright spot in the quarter, up 90 basis points versus negative 140 basis points in the second quarter of this year. However, same-facility pricing expanded 10.5%, up sequentially from 4.5%. Management indicated that payer mix was largely unchanged quarter to quarter, with the step up in revenue-per-case driven by both higher acuity procedures and from seeing the initial benefits of contract negotiations with private payers. We expect management to renew roughly one third of its agreements in 2018 and think it's likely we continue to see pricing upside from these activities over the coming years as remaining contracts are renegotiated. This was a primary tenet of CEO DeVeydt's strategy, and we're encouraged to be seeing the benefits of his prior experience with a national payer pay off so quickly.

The other pillar of the firm's strategy has also seen material progress, with management divesting 19 physician practices and five surgery centers so far this year. Further, management has sold off a handful of its optical assets, which we had speculated would be a near-term priority. On the other side of the equation, it looks like the company is on track to deploy nearly $100 million in capital toward acquiring surgical assets for the full year, ahead of initial expectations.

While we remained concerned about the firm's sizable leverage profile, we're relieved to see management enter into swap agreements that transition the mix of its debt from roughly 60% of outstanding principal carrying variable-rate interest to nearly 75% now effectively locked-in at fixed rates. We think this should help sustain improving firmwide profitability in an environment of rising rates.