A Healthy Challenge for Hospitals
The industry must spend again as patient volumes pick up.
A Poor Economy Drives Lower Health-Care Utilization
With the economic recession and ensuing rise in unemployment, hospital services have declined as patients forego elective procedures. Orthopedic surgeries and child births have been particularly affected. Same-facility surgical procedures declined at HCA Holdings (HCA) and Tenet Healthcare (THC) in 2010, while inpatient admissions have been flat to slightly down since 2007. The increasing unemployment rate, which increased from an average rate of 4.6% in 2007 to 9.6% in 2010 according to the Bureau for Labor Statistics, also has affected privately insured patient volumes. A decline in the private payor patient segment puts hospitals at particular risk since Medicare and Medicaid, the two other largest patient segments, often provide reimbursement payments that are below hospital operating costs. Private patients therefore often provide the majority, if not all, of hospital profits.
Hospital Cost-Cutting Offsets Weak Patient Volumes
Despite the decline in patient volumes, hospitals have offset top-line pressure through cost-cutting measures since the recession. Chart 1 below shows hospital earnings before interest, taxes, depreciation, amortization, and nonrecurring costs (adjusted EBITDA) margin during the last five years. The hospital industry uses EBITDA as a common measure of profitability. Although higher unemployment has resulted in an increasing provision for doubtful account expense, hospitals have been able to drive higher profits by reducing salary, supply, and other operating costs. The average supplies expense as a percentage of sales, for example, reached its lowest point in over three years during the fourth quarter of 2010. Chart 2 shows the decline in average hospital inventory days and inventory turnover during the last decade. We note that 2009 appears to be the inflection point for hospital inventories. The slight decline in provision for doubtful accounts in 2010 on Chart 1 stems from hospitals recognizing less revenue through higher charity care and uninsured discounts. The two hospitals we cover at Morningstar, HCA and Tenet, each drove over 250 basis points in margin expansion during the last five years, while Community and Universal Health witnessed similar EBITDA margin improvement.
Michael Waterhouse does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.