A small earthquake shook the health care industry on the morning of Nov. 9 when it became clear a new administration would take charge, an administration that promised a major overhaul of the system.
What effect will this have on the long-term future of Universal Health Services (UHS, Financial), one of the big names in the field and the operator of numerous acute care and behavioral health facilities?
Does it have the earnings and cash flow power to withstand potentially bad news when the new administration takes office in January?
This is an examination of the company’s strengths and weaknesses, as well as its financial position and valuations, with an eye on news that might come in 2017.
History
1979: The company is founded in King of Prussia, Pennsylvania by Alan Miller and former colleagues at American Medicorp.; that same year, the company signs its first management contract and makes the first of many acquisitions to come.
1980: Universal Health Services goes public on NASDAQ.
1986: Sets up the Universal Health Realty Income Trust (UHT, Financial).
1991: The company’s listing moves from NASDAQ to New York Stock Exchange.
2003: Makes first appearance on the Fortune 500 list.
2007: Sets up UHS Building Solutions Inc., “to build better quality hospitals for third parties at lower cost.”
2014: Acquired Cygnet Health Care Ltd., which operates 17 facilities in the United Kingdom.
2016: Named to Fortune’s World’s Most Admired Companies list: first in social responsibility and second overall in health care industry.
History based on information at the company website.
Now a 37-year-old company, Universal Health has grown rapidly through its own initiatives and through dozens of acquisitions (most not shown here).
Universal’s business
Through subsidiaries, Universal Health Services operates hospitals with an emphasis in two areas: acute care and behavioral health (unless otherwise noted, information in this section comes from the company’s 10-K for 2015).
It reports owning or operating, as of Feb. 25:
- 24 inpatient acute care hospitals, three free-standing emergency departments.
- 213 inpatient and 16 outpatient behavioral health care facilities.
- It operates those facilities in 37 states, Washington, D.C., the United Kingdom, Puerto Rico and the U.S. Virgin Islands.
- It also had one major hospital under construction and miscellaneous interests in other health care organizations.
Universal also owns just under 6% of Universal Health Realty Income Trust.
Baron Funds calls Universal Health “the country’s largest provider of behavioral health services” and “the dominant acute care provider in some of the fastest-growing markets in the U.S.” The shareholder letters adds, “We continue to like Universal’s positioning and prospects.”
Comments: United Health has two main lines of business, acute care hospitals and behavioral health facilities, which it builds or buys in areas with faster than average population growth. Through this growth, it has leading positions in the two sectors in which it competes.
Revenue
According to the May investor presentation, the company derived 51% of its 2015 revenue from acute care and 49% from behavioral health.
The 10-K for 2015 reports the relative contributions of different payors this way:
- Managed Care (HMOs and PPOs): 52%.
- Medicare & Medicaid: 35%.
- Other: 13%.
Total revenue for 2015 totaled $9 billion, and this 10-year chart shows how revenue has grown in the past decade:
Comments: Two well balanced revenue streams (acute care and behavioral health), with slightly more than half of revenue coming from Managed Care sources, while about one-fifth came from government sources.
Competition
In its 10-K, Universal Health says it operates in a highly competitive market. It notes that drivers of competitiveness include regulatory and technological changes, greater use of managed care payment systems, pressure to restrain costs, and a shift to outpatient treatment.
Hoover's lists its top three competitors as:
- Tenet Healthcare Corp.Ă‚ (THC, Financial).
- Community Health Systems Inc. (CYH, Financial).
- HCA Holdings Inc. (HCA, Financial).
This table from GuruFocus shows how the four companies compare on revenue and market cap:
All three competitors generate significantly more revenue than Universal Health, with the next highest bringing in more than twice as much.
Comments: Universal Health is a sizable company thanks to organic growth and acquisitions but still smaller than three of its major competitors.
Moat
Morningstar gives Universal Health a Narrow Moat rating.
At the Wall Street Investment Management website, they’re more on the glass half-empty side, saying (in 2015), “UHS does not have an economic moat in our opinion. UHS relies on superior execution for success.”
It might be argued, of course, that being able to deliver superior execution provides a real competitive advantage.
Comments: Theoretically, barriers to entry are low to potential new competitors yet Universal Health enjoys a moat thanks to a vast maze of government regulations and technological competencies. And as a well-established player in the field, it is unlikely to suffer heavy market share losses to existing competitors in the next few years.
Growth
To start with context, here is revenue growth over the past 25 years:
Universal has grown its top line quite consistently throughout that time.
The big question for the company and industry is a political question: What will happen with the Affordable Care Act and potential replacements?
At the same time, though, the company has several forces working in its favor. In its May 2016 investor presentation the company said these forces included:
- Demographics (thanks to the baby boomers, the population is aging).
- Improved economic conditions in the communities it serves.
- Leading market positions.
- Favorable business trends in both segments it serves.
- New opportunities created by health reform.
Perhaps most importantly, and regardless of the political winds, the baby boomers are consuming ever-increasing amounts of health care:
Comments: While the political situation is an immediate concern, the underlying environment suggests good growth prospects for at least another decade or more.
Other
Universal Health Services is headquartered in King of Prussia, Pennsylvania.
On Dec. 31, 2015 the company had about 72,600 employees in the U.S., and about 2,000 in the United Kingdom.
Its 2015 fiscal year ended on Dec. 31.
Chairman, CEO: Alan Miller, age 78, founder of the company.
Chief Financial Officer, Senior Vice President, Secretary: Steven Filton, age 58, and holder of these positions since 2003.
Information about the officers from Reuters.com.
Ownership
Thirteen investment gurus followed by GuruFocus have holdings in Universal Health Services. Lee Ainslie (Trades, Portfolio) holds the largest position, 4,584,358 shares. Second and third positions belong to Vanguard Health Care Fund (Trades, Portfolio) and Andreas Halvorsen (Trades, Portfolio).
A very high level of ownership among institutional investors is immediately apparent in this GuruFocus table:
The number of shorts is relatively low. Among insiders, Miller (818,621 shares) and Filton are the biggest holders.
Comments: A strong showing by the insiders/top executives, ensuring their interests are aligned with those of shareholders, the overwhelming majority of whom are pension funds, mutual funds and other institutional investors.
By the numbers
Comments: A nearly $12 billion company by capitalization; price is currently midway between the 52-week high and low; a reasonable return on equity; a small dividend and a relatively few shares bought back in 2015.
Financial strength
In the GuruFocus system, Universal Health garners a mediocre 5 (out of 10) for financial strength and a very good 9 (again, out of 10) for profitability and growth.
The Cash to Debt metric, showing red, means GuruFocus thinks Universal Health’s debt situation is less healthy than most of the players in its industry and versus its own history.
GuruFocus notes that the cash-debt ratio is 0.02, which means Universal Health could not pay off its debt using cash in hand (that would require a ratio of at least 1.0).Ă‚
It also notes that the cash-debt ratio is below that of 92% of other companies the Global Medical Care industry. The industry median is 0.31 compared with 0.02 for Universal Health.
As the following chart shows, the company’s debt roughly tripled in 2010:
Since then, the level of debt has declined slightly, but not enough to be significant. It says, in the 10-K for 2015, that it needs substantial funding for acquisitions, as well as ongoing capital expenditures.
The following excerpt from the May 2016 investor presentation shows the company’s allocation of capital:
Has Universal Health used the money wisely? Has it justified the use of borrowed capital for capital expenditures and acquisitions? This chart shows the company has more than doubled its earnings since the beginning of 2010:
It has also more than doubled its earnings per share.
Where the long-term debt has made an exceptional difference shows up in this chart of free cash flow (which matters to growth-oriented companies):
Comments: Universal Health took on a heavy debt load but has used the resulting growth in cash for acquisitions as well as pumping up its earnings and free cash flow.
Valuation
Of the thousands of American stocks followed by GuruFocus, only 139 have the coveted 5-Star rating. That means Universal Health has consistently delivered bigger earnings every year. From another perspective, it means the company is more likely than most to deliver capital gains to investors (and have a lower likelihood of losing money) over the long haul.
The DCF (Discounted Cash Flow) calculator suggests a higher price ahead:
At that valuation, $186.70, the company has a 35% margin of safety.
The price-ernings (P/E) ratio sits at 17.19, and that’s comfortably within the normal range set over the past 25 years (note that the chart stops at the end of 2015):
The PEG ratio (Price/Earnings divided by average Earnings Growth) comes in at 1.46, which puts it in the middle of the fair-value range (and lower than it was when this chart ended on Dec. 31, 2015):
The 12-month consensus price target among analysts followed by NASDAQ.com is $143.50, a roughly 17% gain. And for most, this is a Buy stock:
Comments: Given the evidence, it appears Universal Health is reasonably valued at the price of $122.08.
Conclusion
Whatever its current valuation, there’s a high probability the price of Universal Health Services will pitch sharply higher or lower when (or if) the government’s position is clarified.
Yet over the longer term, the company should power through this issue and continue growing its earnings. However it is funded, health care can’t help but grow, and it’s unlikely new competition will eat into Universal’s market share.
Given the size of the debt load, this is not a stock for conservative value investors, nor is it a stock for income investors. This company is focused on growth.
For value investors with a long horizon, Universal Health is worth consideration. It is a 5-Star predictability stock with the capability of generating a lot of cash and using that cash for accretive acquisitions and internal development.
Disclosure: I own shares of a TSX-listed competitor, Medical Facilities Corp. (DR), but not of any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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