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Tenet Healthcare Corp (THC), HCA Holdings Inc (HCA): Why Buy Hospitals?

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Under the Affordable Care Act, also known as ObamaCare, hospitals are in a bind.

Tenet Healthcare Corp (NYSE:THC)

More wellness care should mean lower patient counts. The Centers for Medicare and Medicaid Services are pushing automation for best practices, and checklists for operations, aiming to lower re-admission rates. Mistakes will no longer be tolerated, financially. While bringing more people into the pool will reduce the number of uninsured whose care must be accounted for, this may not result in higher capacity utilization.

As a result, hospital chains are under pressure. Yet many have matched the market’s move upward since the act was signed. At least two have engineered triple-digit gains in their stock price.

The question for investors, however, is what happens next. Should you be buying these stocks for capital gains, for yield, or for some other purpose?

Tenet Flies Highest

The highest flyer in the group is Tenet Healthcare Corp (NYSE:THC), up 160% since April 2010. Most of that move, however, has come just in the last year.

The catalyst was a 1:4 reverse stock split last October, which came alongside a $500 million stock buyback. That buyback represented 10% of the company’s equity, at current prices, and almost twice as much at the time the split occurred.

The purpose of the move was to fund acquisitions, and in June it announced a big one, agreeing to acquire Vanguard Health Systems, Inc. (NYSE:VHS) for $4.3 billion, a roughly 70% premium over the pre-deal price.  This included $2.5 billion in debt, much of it taken out at high prices, which Tenet Healthcare Corp (NYSE:THC) could profitably retire, making the deal accretive. Vanguard Health Systems, Inc. (NYSE:VHS) owned 28 hospitals, and complementary facilities, which Tenet Healthcare Corp (NYSE:THC) added to its own 49 hospitals and 126 outpatient centers.

Financially, however, Tenet is not much to write home about. Revenues of $2.387 billion for the first quarter of the year were little changed from the previous year’s $2.302 billion. Tenet Healthcare Corp (NYSE:THC) actually lost money in that quarter, and its balance sheet shows a debt-to-assets ratio of over 50%, which reads like they own auto factories. The only bright spot is operating cash flow, which has been on a steady upward track and was almost $600 million in 2012.

One way Tenet Healthcare Corp (NYSE:THC) has tried to keep growing is by playing hardball with insurers like United Healthcare, with which it has been battling out a reimbursement fight in the California desert.

So you don’t have a great company. It’s moving due to financial engineering, not operations. It pays no dividend, and its current price/earnings (PE) multiple is a sickening 68.22. Overall, a good stock to avoid.

Yet there are buyers. Why? Let’s look elsewhere for an answer.

HCA Flies Lower

HCA Holdings Inc (NYSE:HCA) owns 157 acute care hospitals, along with five psychiatric and one rehabilitation hospital. It did not join the move upward in price, and is only up 24% from the price it fetched five years ago.

Instead of focusing on acquisitions, HCA Holdings Inc (NYSE:HCA) has focused on yield. It paid $8.50 in dividends during 2012, mainly to avoid the consequences of higher tax rates that kicked in during 2013. This makes sense when you realize that insiders own 172 million shares, out of a total of 446 million.

The company’s finances are little different from those of Tenet Healthcare Corp (NYSE:THC). During the last quarter it brought just 7.5 cents in every dollar down to operating income, and only half of those escaped tax. Total revenue is only 10% better than it was in 2009, and it actually has more debt than assets. Operating cash flow, however, is approaching $4.5 billion, and the slope of that improvement is better than Tenet’s.

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