This week’s bond review focuses on one of the nation’s largest publicly traded hospital companies. Community Health Systems, Inc. (NYSE: CYH). CYH has spent the past few years divesting hospitals in an effort to reshape its portfolio towards urban and suburban markets. The company continues to make that shift and has now added urgent care centers in some of those markets to help drive additional patients to its hospitals. Its fourth quarter and full-year 2018 results look to be an indicator that the transformation is gaining a foothold.
- Fourth quarter net operating revenues were up 12.9% year-over-year.
- Adjusted EBITDA for Q4 was up 2.4%
- Full year 2018 same-store revenues were up 3%.
These results were achieved with almost 10% less hospital locations, giving credence to the company’s divestitures and efforts to reduce costs. Healthcare is a non-cyclical industry – it is constant and consistent- and it is a growing need in this country. For investors looking for additional diversification in their portfolios, these short maturity bonds are an excellent complement to more cyclical industries such as commodities, housing, or retail. As such, they make an excellent addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, which has historically done well in a rising interest rate environment, shown below.
Community Health Systems (NYSE: CYH) recently posted its fourth quarter and full year results for 2018. Although the company has spent the last few years divesting hospitals that are not considered part of its core strategy, the company did register gains in revenues and adjusted EBITDA, among others.
- Net operating revenues for the fourth quarter (three months ended December 31, 2018) totaled $3.5 billion, representing a 12.9% increase compared with $3.1 billion for the same prior year period.
- Adjusted EBITDA for the fourth quarter registered $419 million, as compared to $409 million for the fourth quarter 2017, representing an increase of 2.4%.
- The company’s adjusted EBITDA margin of 12.1% was the strongest performance of 2018.
- For the full-year 2018, CYH same-store net revenues increased approximately 3%.
Wayne T. Smith, Community Health Systems chairman and chief executive officer commented on the company’s fourth quarter results. “For the quarter and the full-year, our net revenue and adjusted EBITDA came in towards the high end of our guidance, and we actually beat consensus.” Indeed, for its fourth quarter results, CYH did manage to beat analysts’ expectations, with EPS beating analyst’ estimates by $0.17 and quarterly revenues beating analysts’ estimates by $70 million.
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 106 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.
Continuing to Streamline and Improve its Offerings
Over the past few years, CYH has worked diligently to streamline its portfolio of hospitals, choosing now to focus in more urban areas, forsaking its hospital locations in more rural areas of the country. Today, 80% of the company’s hospitals are in locations with greater than 50,000 residents. And if you factor in future anticipated divestitures, then 95% of its hospitals are in markets with greater than 50,000 residents. These markets have better population growth, better economic growth and lower unemployment, all of which provides an opportunity for growth potential.
The other development that is helping to shape CYH’s offerings is its entry into lower cost healthcare settings – urgent care, walk-in care and primary clinic care networks across its markets. In 2018, the company increased its number of freestanding emergency department, urgent care and walk-in clinics by 10%. These urgent care clinics help to support CYH’s existing hospital markets and networks.
Healthcare – Consistent Revenues
Unlike many industries, such as oil and gas, retail, and housing, healthcare is not cyclical. There are always individuals needing and seeking care for sickness or injury. And there are two factors currently driving the demand for healthcare in the U.S. – an aging population and the growing incidence of obesity.
The aging baby boomer generation (those individuals born between 1946 and 1964) currently makes up between 20% to nearly 25% of the total U.S. population according to various estimates. And according to the U.S. Census Bureau, individuals aged 65 and older in the United States comprise the fastest growing segment of the population, with nearly 50 million people currently aged 65 and over living in the U.S. This segment is expected to grow to more than 63.5 million by 2025, and by 2030, those aged 65+ are expected to grow to over 71 million individuals. This represents a 42% increase in the 65-and-older segment of the population over the next 13 years. As a result, the number of patients and the volume of hospital admissions are expected to grow over time. The aging population and increasing life expectancy are driving increased demand for health care services.
The second demographic that is driving healthcare is the increase in obesity among the U.S. population. The U.S. population is getting heavier. The latest statistics from 2017 indicate that overall, 39.8% of the American population is medically obese as reported by the Center for Disease Control and Prevention (CDC). The total adult population that is overweight, including obesity if now at 71.6% according to the CDC. With overweight and obesity comes the increased risk for many health conditions, including but not limited to heart disease, high blood pressure, diabetes, joint problems, and increased risk for certain types of cancer.
Interest Coverage and Liquidity
Interest coverage is of paramount importance to bondholders as it indicates the issuer’s ability to service its existing debt. For its most recent quarter, CYH had operating income (without the effects of non-cash depreciation and a non-cash impairment charge) of $407 million and interest expense of $257 million for an interest coverage of 1.5x. In terms of liquidity, as of December 31, 2018, CYH had total cash of $196 million.
For bondholders, the risk is whether CYH can continue to streamline operations, improve its balance sheet and continue to build revenues with a smaller portfolio of hospitals. The company has done a good job in divesting non-core properties, with a total of 11 hospitals divested in 2018. Its entry into the urgent care clinic space is a shrewd method of directing more patients to its hospitals. And, in spite of the company having nearly 10% less hospital locations at the end of 2018 than at the end of 2017, the company’s adjusted EBITDA only dropped by 3.5%. The company is working diligently to improve its margins by streamlining costs as well. Given these factors, it does appear that the over 23% yield-to-maturity on these short-term bonds does outweigh the risks identified.
In Q4 2018, CYH settled and made payments totaling $266 million for a lawsuit related to Health Management Associates, one of the company’s subsidiaries. Although this was a one-time payment, it did affect the company’s profits.
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.
Summary and Conclusion
The face of healthcare is changing. Over the past few years, Community Health Systems has been working to address those changes. It has divested its non-core hospitals with a focus on more urban and suburban markets. Along with this, it has entered and increased its presence in the urgent care clinic space, a smart move in directing additional patient traffic to its hospitals in those same markets. This transformation looks to be gaining a foothold as fourth quarter revenues were up, even with less hospitals to contribute. With the demand for healthcare on the rise, these short-maturity bonds, with and outstanding yield-to-maturity in excess of 23%, are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, which, historically, has been an excellent investment vehicle in a higher interest rate environment.
Issuer: Community Health Systems
Bond Coupon: 6.875%
Rating: C / CCC-
Yield to Maturity: ~ 23.75%
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Disclosure: Durig Capital and certain clients may hold positions in CYH’s February 2022 bonds.
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