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Morningstar | THC Updated Forecasts and Estimates from 14 Nov 2018

Tenet reported another quarter of decent performance out of its ambulatory care and Conifer segments, which was overshadowed by weakness in its hospital operations. As we update our model, we don't intend to make any major changes to our $27.50 fair value estimate for the no-moat firm, which implies approximately 6.3 times and 10.7 times our updated adjusted EBITDA and earnings forecast for 2019.

The firm's top line continues to exceed our and consensus expectations, driven by strong pricing, with same-facility revenue-per-equivalent-admission up 3.6% after adjusting for the California Provider Fee that was delayed for much of 2017. Same-facility equivalent admissions were consistent with what we've seen year to date, up 30 basis points. Volume weakness in the Detroit market has continued to pressure results, lowering volume growth by 70 basis points alone. Ultimately, the hospital segment's profitability continues to disappoint, with higher costs in the quarter largely driven by $20 million in unanticipated losses on risk-based contracts and $30 million in incremental malpractice expense.

Conifer continues to perform well in expanding its profitability, although we'd take note of declining revenue driven by ongoing facility divestiture programs at both Tenet and other Conifer clients. Management continues to signal that the sale process for this business is ongoing and nearing completion. Interestingly, management's discussion this quarter included options such as a spin-off of the asset, which we think might be more feasible than an outright sale. We continue to believe that the significant customer concentration at Conifer presents a hurdle for prospective buyers.

Ambulatory care continues to be a bright spot for the company, with same-facility revenue up 6.7% helped by case growth of 5% and pricing up 1.6%. Adjusted EBTIDA less facility-level noncontrolling interest expanded 11.5%, in line with our longer-term expectations for the segment.

Management's initial outlook for 2019 came in below our projections, implying 3%-5% adjusted EBITDA growth compared with our expectations closer to a mid- to high-single-digit rate. We have a feeling this could be a relatively easy bar to surpass, as including the roughly $50 million in expected incremental savings from management's ongoing cost-reduction initiative would put Tenet near the low end of that range before factoring in growth expected from Conifer or the ambulatory care segment. That said, we suspect the turnaround in Detroit might be taking a bit longer than expected, which may pressure results into next year, with talk of organic growth in the market pushed to the second half of 2019.