This week, Durig Capital looks at the healthcare sector to review one of the largest publicly traded hospital companies in the United States. Community Health Systems (NYSE:CYH) has spent the last few years rationalizing its portfolio of hospitals. The company is beginning to realize the effects of this strategy as evidenced by its same-store results for the second quarter.
- Same-store admissions increased 2.3% as compared to one year ago.
- Same-store net operating revenues increased 4.9% compared to second quarter 2018.
- Net cash provided by operating activities in the second quarter was $132 million versus net cash used in operating activities of $(12) million one year ago.
With its portfolio now representing stronger performing assets, Community Health Systems has a greater opportunity for improved growth potential. Healthcare is not a cyclical industry and is an essential service for every country and culture. Community Health Systems’ 2022 bonds have an outstanding yield-to-maturity of about 23.5%, giving investors an opportunity for not only diversification, but increased portfolio return as well. Durig Capital has previously reviewed these bonds, and given CYH’s recent performance, these bonds appear to be an excellent choice for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
Second Quarter 2019 Results
After selling a slew of hospitals over the past few years to pare down its portfolio to the best performers, Community Health Systems is starting to see the benefits of its strategy. Wayne Smith, Chairman and Chief Executive Officer of Community Health Systems praised the company’s second quarter results:
“It’s worth noting that our second quarter volume and net revenue growth marked our strongest performance since the first quarter of 2015.”
At first glance, the numbers don’t appear to back this statement, but if one digs a little deeper, the fog begins to clear. When you sell 11 hospitals, as CYH did in 2018, that affects revenues. Those 11 divested hospitals represented annual net operating revenues of $950 million. So, of course, revenues will decrease year-over-year. However, CYH had encouraging news to report on its same-store numbers (same-store operating results exclude the results of the hospitals divested or closed in 2018 for the six months ending June 30, 2019).
- On a same-store basis, admissions increased 2.3% and adjusted admissions increased 1.8% compared with the same period in 2018.
- On a same-store basis, net operating revenues increased 4.9% for the second quarter compared with the second quarter 2018.
- Net cash provided by operating activities in the second quarter was $132 million, compared to net cash used in operating activities of $(12) million for the second quarter 2018.
The company’s second quarter investor presentation provided a summary of this information along with additional information regarding same-store performance in the second quarter and year-to-date.
CYH has indicated it is winding down its divestitures by the end of 2019. Company management has also indicated that its continued execution of its strategic initiatives along with effective expense management “will lead to incremental growth in the back half of the year.”
About the Issuer
Community Health Systems (NYSE:CYH) is one of the largest publicly traded hospital companies
in the United States and a leading operator of general acute care hospitals and outpatient facilities in communities across the country. The company provides healthcare services through the hospitals that it owns and operates and affiliated businesses in non-urban and selected urban markets throughout the United States. It generates revenues by providing a broad range of general and specialized hospital healthcare services and outpatient services to patients in the communities in which it is located. CYH currently owns or leases 105 hospitals in 18 states across the nation. The company generates revenues through the payments it receives for its services to its patients. These payments come from governmental agencies (Medicare and Medicaid) private insurers, and directly from the patients served.
Paring Down for Growth
Over the past few years, Community Health Systems has significantly reduced its portfolio of hospitals across the country. As a result, the company now has a stronger portfolio of assets. Its remaining hospitals are in more substantial markets with better population growth, better economic growth and lower unemployment, which provides greater opportunity for improved growth potential.
Healthcare – Consistent Revenues
Healthcare, unlike some other industries such as housing, retail, or oil and gas, is not cyclical. Healthcare is an essential service / need in every society and culture. Simply put, there are always people who need care for either sickness or injury. In the United States today, there are two major contributors increasing the need for healthcare – the growth in our senior population (those aged 65+) along with increasing obesity rates.
America is getting older. In 2018, there were 52 million seniors living in the United States. By 2060, that number is projected to nearly double to 95 million seniors. This means that those aged 65 and up will make up 23% of the population, up from 16% today. Due to this aging of America, hospital admissions are expected to grow. Already, studies show that those aged 65 and older are hospitalized three times as often as their younger counterparts – those 45 to 64 years old. In addition, older patients tend to have a longer average length of stay in the hospital compared to younger patients, and because of their advanced age, often have increased medical needs. As our senior population grows, so will the need for healthcare.
The growing epidemic of obesity is another factor that continues to drive the need for healthcare. According to the American Medical Association, data from the most recent National Health and Nutrition Examination Survey (NHANES) completed in late 2018 now indicates that the nation’s obesity rate is nearly 40% for adults and 18.5% for children ages 2 to 19 years old. As the nation’s obesity rate rises, so does the incidence of health conditions associated with obesity. These include high blood pressure, diabetes, heart disease, joint problems, as well as an increased risk of certain types of cancer.
Interest Coverage and Liquidity
Interest coverage in an indicator for investors as to an issuer’s current ability to service its existing debt. Liquidity is also important, as it helps a company to smooth out variations in cash flow from quarter to quarter. For the second quarter, CYH had operating income (without the effects of non-cash depreciation and impairment charges) of $297 million and interest expense of $265 million for an interest coverage of 1.1x. As of June 30, 2019, CYH had ample liquidity, with over $200 million in cash and an additional $235 million in undrawn revolver capacity.
The risk for bondholders is whether Community Health Systems can indeed continue to improve its operating results while continuing to address its debt load. Hospitals are, by their very nature, capital intensive to build and to run. Community Health Systems has done the hard work of deciding which hospitals to retain and which to sell. The results appear encouraging as evidenced by the same-store sales statistics in the second quarter. Regarding debt, CYH appears to have adequate resources to address its debt maturities between now and 2022 (which includes these 6.875% couponed 2022 bonds), but it will have to address its large debt load which matures in 2023. Given that is four years away, CYH should have ample time to address this through debt reduction and debt refinance.
With the 2020 U.S. Presidential race beginning to heat up, there has been a lot of talk surrounding healthcare reform (again) and that has led to discussions of so-called “single payer healthcare”, whereby the government would essentially regulate all healthcare and private insurance would be a thing of the past. While some see single payer healthcare as a panacea for our current system where insurance companies call the shots and medicines and procedures are often too expensive even with insurance, it’s not as easy as it seems. Vermont tried and failed to implement single payer healthcare. Public financing will not work until you get costs under control. If single payer healthcare becomes a reality, companies like Community Health Systems will certainly be affected. Payouts for care are likely to be much less under that type of system which would affect CYH’s profitability.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Generally, there is reduced risk for investors who invest in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio due to its diversification across many bond issuers and industries as compared to the purchase of individual bonds. Also, the FX2 Portfolio has historically outperformed the portfolios where investors have chosen bonds individually. Durig Capital currently holds this bond in its FX2 Portfolio.
Summary and Conclusion
Community Health Systems had a fantastic second quarter as noted by its CEO, Wayne Smith. The company has done the hard work of selecting its core assets and selling the rest. Now, with strategic initiatives designed to increase revenues and effectively manage costs, the company appears to be turning the corner and headed to a more profitable future. The company’s 2022 bonds are currently selling at a significant discount, which translates to a whopping 23.5% yield-to-maturity. Healthcare is essential, and these CYH 2022 bonds provide investors with a fantastic opportunity to participate in the healthcare sector. With this in mind, these 2022 bonds are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.
Durig Capital has several high yield portfolios available, click below to learn more.
Issuer: Community Health Systems
Bond Coupon: 6.875%
Rating: C / CCC-
Yield to Maturity: ~ 23.50%
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Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services. Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured, or at Interactive Brokers. We have now started offering our highly successful FX2 service to clients of other Registered Investment Advisors through segregated accounts at TD Ameritrade. Please ask us to learn how this might work for you and your current advisor.
Disclosure: Durig Capital and certain clients may hold positions in CYH’s 2022 bonds.
Disclaimer: Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. The high yield strategies presented in this review by Durig Capital may not be suitable for all investors. This is not investment advice from Durig Capital, nor a specific recommendation to buy or sell securities. If you have any questions or concerns about its suitability for your personal investment, you should seek specific investment advice from a registered professional before making an investment decision.
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Randy Durig, Durig Capital, Inc.
A Registered Investment Advisor