EUR 850.00 For Business Accounts Only

Morningstar | Hospital Segment Weakness Overshadows Otherwise Strong 2Q Results; Raising FVE

Tenet Healthcare reported another in a string of strong quarters that surpassed our profit expectations while coming in just shy of our revenue forecasts. We'll likely raise our fair value estimate for this no-moat company by a mid-single-digit percentage to account for modestly higher near-term cash flow forecasts driven by an improved cost structure in both the hospital and Conifer segments, along with the cash flows received since our last update.

While the firm's cost-reduction efforts have yielded results faster than anticipated, top-line softness in its hospital segment accounted for the bulk of the revenue shortfall in the quarter. Both same-facility equivalent admissions and pricing decelerated off impressive results in the prior two quarters, with volume weakness centered around the firm's Chicago and Detroit markets. While Tenet expects to close the sale of its three Chicago facilities by year-end, management hopes to see Detroit improve into 2019. Revenue per adjusted admission grew just 1.6% after adjusting for the California Provider Fee that was delayed for much of 2017, down from 4.1% in the first quarter of this year. While only one quarter's worth of data, t his step-down is somewhat surprising given the context of Tenet's recent performance and the continued strength reported by peer HCA. This drove the bulk of management's $20 million reduction in full-year hospital EBITDA guidance, entirely offset by an improved outlook for Conifer.

Turning to Conifer, management indicated the sales process has been narrowed down to a handful of potential strategic and financial buyers. We've been somewhat skeptical that a satisfactory bid for the asset will emerge. With the business set to generate $80 million in incremental EBITDA this year (on slightly lower revenue), we think expectations for an acceptable price have only gone up over the last six months, which may make finding the right buyer more difficult.

Finally, the ambulatory surgery business continues to grow nicely, with same-facility systemwide case growth of 4.3%, helped by revenue per case that expanded roughly 2.4% in the quarter. Management indicated that the business has deployed roughly $120 million in capital toward acquisitions year to date, and appears likely to exceed the $100 million to $150 million range indicated at the start of the year. Management completed its remaining buyout of minority partners in the business during the quarter, and now owns 95% of the joint venture. This simplified ownership structure should improve cash flow visibility and give management more flexibility in its capital deployment policy over the coming years.