HCA Healthcare’s Service Optimization & Capabilities Support Long-Run Growth (NYSE:HCA)

HCA Healthcare (NYSE:HCA) is a Nashville, Tennessee-based operator of healthcare facilities with a major presence across 21 states and parts of the United Kingdom between its >2,000 sites of care. The firm maintains various hospitals, surgery centres, urgent care centres, and physician clinics as part of its healthcare facility operations.

Through these activities, HCA Healthcare has seen Q1 revenues of $15.59bn- a 4.32% YoY increase, alongside a net income of $1.36bn- a 7.07% increase- and a free cash flow of $606.00mn- a 25.21% increase.

Introduction

Central to the long-run success of HCA is its fivefold growth strategy, which ultimately enables a virtuous cycle of superior service, scalable growth, and operational excellence. By delivering peerless experiences for partners and patrons, HCA is better able to retain talent, enabling the development of comprehensive products and services for patients, supporting wider accessibility, empowering integrated care, and ultimately providing a better product and delivering better profitability for all stakeholders.

HCA’s scale advantage, combined with integrative offerings and a strategy which emphasizes judicious capital deployment and margin-expanding tactics, alongside a moderate undervaluation, lead me to rate the company a ‘buy’.

Valuation & Financials

General Overview

In the TTM period, HCA- up 80.58%- has seen superior price action to both the healthcare industry, as represented by the NASDAQ Health Care Index (IXHC)- up 14.15%- as well as the broader market, represented by the S&P 500 (SPY)- up 17.50%.

This price performance reflects the inelasticity of HCA’s product, thereby rendering it a secure investment in the face of macro volatility, as well as the firm’s ability to pass on increased medical technology and pharmacological costs. Moreover, while a majority of the healthcare industry experienced share price declines on UnitedHealth’s (UNH) extrapolation of increased healthcare costs due to surgical procedure frequency, this just indicates greater demand for HCA’s products and real estate.

Still, I believe HCA’s operational strength and continued undervaluation leave room for the stock to grow and remain a highly dependable investment for years to come.

Comparable Companies

As the largest healthcare facility provider in the world, HCA’s scale is solely matched and competed with by governmental organizations and non-profit/private providers. As such, although they may not match HCA in scale, public companies with healthcare facilities at their core are most comparable. This encompasses Pennsylvania-based hospital operator Universal Health Services (UHS), United Surgical Partners International-owner Tenet Healthcare (THC), mental and behavioural healthcare facility provider Acadia Healthcare (ACHC), and post-acute healthcare service provider Encompass Health (EHC).

As demonstrated above, although HCA has seen the best YoY price action, this growth has somewhat slowed over the past quarter, experiencing the second-worst price performance in the trailing three months. Despite the widely positive stock movement, though, HCA’s relatively strong multiples-based valuation and growth metrics signal the potential for price growth.

For instance, although HCA does maintain middling multiples when concerned with P/E, P/S, and P/CF, the firm does so on the back of a significantly greater scale, meaning residual returns for the stock support a wider range of possible allocative avenues.

Additionally, HCA overperforms when assessing the company on a growth basis, with the highest ROA and profitability among peers as well as the best 5-year revenue growth and second-best earnings growth.

However, much of this growth comes at the cost of large capital reinvestment and M&A activity, which has led to a disproportionately high debt/assets of 0.77.

Valuation

According to my discounted cash flow valuation, at its base case, the fair value of HCA is $364.87, meaning at its current price of $303.48, the company is undervalued by 17%.

My DCF model, calculated over 5 years without perpetual growth, assumes a discount rate of 10%, incorporating both the higher debt levels of the company and addressing the higher cost of capital, leading to a higher discount rate regardless of lower negative equity price volatility. Additionally, slightly lower than the 5-year average revenue growth rate of 6.78%, I projected a revenue growth rate of 6%, with largely predictable future cash flows and no obvious catalyst for revenue growth acceleration or reduction.

Alpha Spread’s multiples-centric relative valuation tool calculates that HCA is undervalued by 36%, meaning, at its base case, HCA’s relative value should be $475.40.

However, Alpha Spread’s model is unable to holistically incorporate the firm’s higher debt levels and thus does not accurately represent HCA’s value.

As such, using a weighted average of my DCF and Alpha Spread’s model- weighed towards my DCF- the fair value of HCA should be $386.76, with the stock currently undervalued by 22%.

Integrated Offerings & Operational Excellence Drives Accretive Growth

Through a combination of human capital and facility service capabilities, HCA seeks to support clients with the utmost efficiency and effectiveness. The healthcare facility provider and operator has manifested this initiative through four primary efforts; for the provision of adequate nursing talent volume and quality, HCA has improved care team support and strengthened educational and academic partnerships, while, supporting care for patients, HCA has improved its digital and operational technology platforms, simultaneously enhancing clinical practice on a performance and compliance level. Furthermore, HCA seeks to expand access to its network through the expansion of its physician practices and urgent care clinics, while streamlining whole business integration through accelerated standardization.

This feeds into HCA’s broader goal of widening its enterprise capabilities, inclusive of workforce development, tailored towards HCA, care transformation for maximized efficiency, partnerships with digital and health tech partners, overall automation and hybridization of patient data and procedures, moat through scale, and general financial resilience driven by strategic operational and financial sourcing and management.

With its range of healthcare facility offerings, HCA ultimately seeks to balance investments in growth, with $44.1bn of the firm’s 2022 cash flows going towards organic growth and M&A, and the rest returned to shareholders via a blend of dividends and opportunistic share repurchase programs.

Wall Street Consensus

Analysts generally support a positive view on HCA, projecting an average 1Y growth rate of 4.50%, to a price of $317.14.

Even at the minimum projected price of $275.00- a 9.38% YoY decline- analysts price-in low volatility, a product of HCA’s operational moat and strong repurchase program.

Risks & Challenges

Interest Rates Have an Acute Impact on HCA

The physical nature of HCA’s businesses inherently leads to a greater need for operational expenditure, while HCA’s focus on scale-above-all lends itself to greater capital expenditure. This, however, has led HCA to take on significant debt. As such, HCA remains highly sensitive to interest rate movements which dictate the firm’s ability to reinvest and materially affect HCA’s current cash flows and future cash flows.

Inflationary Input Pressures May Reduce Profitability

Although, as a healthcare facility provider, HCA is largely able to pass down costs from pharmaceutical and healthcare technology brands to insurers and consumers, extensive inflationary pressure may result in demand decline or eventual regulatory pressures for price reduction. With the confluence of wage growth, healthcare technology and pharmaceutical price growth, and pro-regulation attitudes surrounding healthcare, HCA may be forced to absorb some excess costs, reducing profitability and shareholder return potential.

Conclusion

Going forward, HCA’s scale advantage, alongside integrated investments in talent and technology, enables superior cost optimization and creates margin-expanding opportunities over the long-run.