A roller coaster in the stock price of a hospital operator named Community Health System (NYSE:CYH) caught my eye the other day. Its stock price has seen its ups and downs over the last four years since the global financial crisis in 2008. The bottom for the last 10 years was in November 2008, when it plunged from $34.6 to $11.35 within just two months. When the rally soon followed, the stock reached its high in March 2010 and March 2011 at more than $40, and now it was back down to the $16 level.
Should investors come in at this price of $16? Can it go even lower or would it experience the same scenario as in 2009 and 2010 to advance nearly three times in just short period of time?
CYH is the largest publicly traded operator of hospitals in the US. .in terms of facilities and net revenues. As of fiscal year 2011, it owned or leased 130 hospitals, including four stand-alone rehabilitation or psychiatric hospitals, in 29 states, with altogether of 19,372 licensed beds. T
he strategy to grow the business is via acquisition. CYH generally targets hospitals in growing, non-urban and selected urban healthcare markets for acquisition. CYH derived its net operating revenues in four sources: Medicare, Medicaid, Managed Care and other third-party payers and self-pay. The largest source is the Managed Care and third-party payers, which account for around more than 50% of total revenue. Medicare is nearly 30%, and the rest is divided equally between Medicaid and Self-pay.
As it grows mainly via acquisition, it is quite common to see consistent increases in revenues over the last 10 years. Along with that, it is a positive for any investors to see constant positive operating cash flow over the same period as well. The same thing happened with its free cash flow, except the year 2006 because of the large capital expenditure spending on the acquisition of eight hospitals and three home health agencies and physician practices.
The current valuation seemed to be so attractive at the earnings multiples of 5x, P/B of 0.6x and P/CF at only 1.7x, and CYH is in the portfolio of four famous gurus: Richard Snow, Joel Greenblatt, Ray Dalio and Ron Baron.
In addition, it is very interesting to look at the insider trades of CYH. It seems like the management knows the action of the stock price performance beforehand.
When the stock reached the high of around $40 per share, the chairman, president and CEO, along with the CFO and executive vice president kept selling substantial amount of shares. And when it was around the $17-$20 area, they began to buy shares.
However, fundamentally, the risk is that CYH employed substantial leverage to acquire hospitals. With the market capitalization of $1.5 billion, the enterprise value reached more than $10 billion, resulting from $8.8 billion in long-term debt. Out of that, 50% of total long-term debt would be due in 2014; $2.8 billion would be due in 2015. So CYH has two more years to go before the debt is due. Just at the middle of November this year, CYH has completed the offering of $1 billion senior notes 8% due 2019, and it intended to use the proceeds to buy back the notes due in 2015, so it has refinanced its debt to expand the time of repayment.
That refinancing is not very sustainable; it would be more reasonable to look at the operating cash flow to see whether it can cover its debt repayment. The CFO of $1.2 billion is only around 13.6% of the total long-term debt, not a very healthy figure. I would prefer to see CYH to use the operating cash flow to pay down debt rather than keep acquiring hospitals for growth, and the acquisition has been mainly financed by debt, increasing the debt level. That growth would not sustainable for the long term.
In addition, Mr. Wayne Smith, the CEO and chairman of the company, has been with the company since 1997, he spent more than 20 years with Humana before joining CYH. The executive contracts have a golden parachute, giving a potential payout of $20 million in the event of a change in control. The executive was rewarded quite handsomely with a total of more than $40 million, and more than half of it went to the CEO and chairman, including restricted stock award, LTIP payout, non-equity comp and other compensation. With the performance paid based on earnings, the management would do whatever to boost the firm’s earnings, and as the three roles in one, the CEO, chairman and president, CYH seems to have too much concentration on decision making of the company’s operations. The executives take too much in compensation, but altogether own only 2.36% of the total company. That is not what I would like to see.
If any investors are interested, they can get into CYH at this price, but with little money compared to the overall portfolio. This position would be considered to be speculation rather than a value position. Only when it slows down growth and pays the debt down, would I feel safer initiating a position in the company.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.