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Summary: We are issuing our Spring Hospital Quarterly, in which we track
the financial and operating performance of the public and private hospital
companies on an individual and composite basis to monitor trends in the
group's results. We believe this piece is a useful part of any healthcare
investor's library.
• We believe investors could finally begin to see some signs of life from the
hospital space heading into 1Q08 earnings. Based on our discussions with
industry contacts, we believe hospital volumes could be up for a rebound
early in 2008. One of the key drivers of the strength is the flu, which had its
biggest impact since 2004, although we would caution that it does not tend
to contribute much to profitability.
• Despite positive expectations heading into earnings, the underlying
long-term fundamentals in the hospital industry remain disappointing. We
believe the sector continues to struggle with a difficult macro environment,
due to a competitive landscape and reimbursement pressures. Bad debt
remains a concern as well. Although hospitals are properly reserved due to
recent one-time charges, we would not be surprised if hospital companies
were forced to take bad debt charges in the back half of the year if the
economy continues on its negative path. Finally, we tend to view the flu as
more of a one-time event, so volumes could still be disappointing going
forward.
• The hospital sector is currently up approximately 2% on a year to date
market cap weighted basis, compared to a decrease of roughly 9% for the
broader market. This has caused valuations to creep up as well, and while
multiples are still below the group's historical averages, we would caution
that valuations do not look attractive compared to the rest of our universe,
as growth in hospitals should pale in comparison to that of other provider
groups. In addition, we believe that relatively positive expectations have
already been priced into hospital stocks heading into earnings, so we see
little upside to the majority of the sector in the near term.
• We continue to remain on the sidelines of the hospital sector at the present
time, given the challenging industry environment. However, one special
situation that we would recommend is Community Health Systems (CYH,
$37, Outperform) due mainly to the opportunities provided by the Triad
acquisition in July of last year. CYH should have a good opportunity to
improve margins and de-lever its balance sheet following the integration. In
addition, CYH's performance is less dependent on the overall economy
than other hospital companies, which makes us more comfortable with its
outlook over the next 12 to 18 months.
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