Tenet Healthcare: Becoming a Very Healthy Business (NYSE:THC)

At the beginning of the year I came to the conclusion that Tenet Healthcare (NYSE:THC) shrunk to grow the business. The company sold some of its facilities to reduce leverage, with divestments reducing debt and improving risk-reward profile as the business reached calmer waters.

The company has seen incredibly strong operational momentum in the first half of the year, while also announcing several divestitures, all of which lead to rapidly lower leverage ratios, but in addition, significantly improved earnings power.

Management deserves a big congratulations for getting some real results here, but with the price of the stock improving quite aggressively, I’m not willing to jump on the bandwagon just yet.

Tenet – A diversified medical services company

Founded in 1969, Tenet is a diversified healthcare services business. A huge billing scandal made it a $200 stock in 2002, it fell to single digits during the recession by the end of the decade.

The company is a hospital and ambulatory platform with full ownership rights or interests in approximately 500 ambulatory surgery centers and hospitals. About three-quarters of sales are generated from the hospital segment, largely complemented by a relatively profitable outpatient segment.

A turnaround and deal-making strategy to drive consolidation saw sales double to $20 billion over the past decade as single-digit operating margins improved to 13-14% from sales. This looks solid, although M&A-induced growth has caused net debt to rise substantially over time.

Current performance

At the start of 2023, the company saw sales down nearly 2% from 2022 to $19.2 billion as EBITDA of $3.5 billion looked solid, yet this is an asset-heavy business that it involves a lot of real estate. Operating profits of $2.3 billion translated into operating margins equal to 12% of sales.

Those numbers are somewhat complicated because they involved partial ownership of many properties and businesses, with GAAP earnings of $411 million coming in at $3.84 per share because earnings of noncontrolling interests actually exceeded net earnings of Tenet investors.

With $27 billion in assets and over $14 billion in net debt, the business was quite strong and therefore susceptible to higher interest rates. The company was on track to grow sales to more than $20 billion in 2023, as a leverage ratio of 4 times seemed quite reasonable, with adjusted earnings exceeding $5 per share.

It shrinks and grows

In an attempt to address leverage, the company began selling off some assets in 2023. This included the sale of three hospitals to Novant Health, which generated after-tax proceeds of $1.75 billion. The divestment sent $552 million in sales out the door, as well as $150 million in EBITDA. The strong margin profile generated relatively compelling sales multiples for these assets.

In addition, the company sold 4 more hospitals to UCI Health, netting $800 million in after-tax revenue, with the deal bringing another billion in sales out the door. In total, pro forma net debt would decrease to $11.5 billion as we fixed the leverage ratio in the middle of the three.

An $89 stock in February looked pretty compelling. The business was down and deleveraging, and with earnings power comfortably topping $5 a share, the stock traded at fair multiples.

This, however, did not automatically appear convincing given the volatile history of the business, the fact that no dividends are paid, as the situation remained difficult to read amid a large minority interest. The ambiguity made me wary of getting involved just yet, but that stance was too conservative as the stock has engaged in a major stretch so far this year.

A huge run

An $89 stock in February, it has seen a huge and relentless rally over the year, with the stock now trading up 70% to $153 a share, after recently trading at a high of $167 of dollars per share.

In February, the company reported 2023 sales up nearly 7% to $20.5 billion, EBITDA flat to $3.5 billion, with GAAP earnings coming in at $5.71 per share (as adjusted earnings were reported a dollar per share higher). The company is targeting 2024 sales at a midpoint of $20.1 billion and EBITDA of nearly $3.4 billion. While both numbers are down on a reported basis, the underlying organic growth was to be found if we factor in the divestments that are being announced.

In addition, the company continued its divestment activity. In February, the company announced the sale of 2 more hospitals to Adventist Health, with after-tax earnings of $450 million and approximately $337 million in sales.

Amid the release of its first quarter results, the company raised its full-year midpoint sales guidance by a hundred million to $20.2 billion, but additionally increased its EBITDA guidance by more than $200 million of dollars, to a midpoint of $3.6 billion. This was very comforting as net debt crossed the $10 billion mark with leverage ratios falling rapidly.

In July, the company reported another compelling set of second-quarter results. This prompted the company to raise its full-year sales guidance by six hundred million to $20.8 billion, despite more asset sales, with adjusted EBITDA now seen at a midpoint of $3.9 billion of dollars!

Net debt was reported at $10 billion, which has already brought leverage ratios down to around 2.5 times. Year to date, adjusted earnings have doubled to $5.53 per share. In less than half a year, a business with earnings power of about $6 per share and leverage of 4x was transformed into a business with earnings of nearly 10 USD per share with 2.5x leverage!

Additional deleveraging

After posting solid second-quarter results, the company announced another divestment. In early August, Tenet announced the sale of its 70 percent stake in Brookwood Baptist Health in a deal that will generate after-tax earnings of $790 million.

The deal includes 5 hospitals, this deal reduces leverage to just over $9 billion here, for a leverage ratio that is quickly moving into the bottom 2 here.

Frankly, there isn’t much need to divest assets or further reduce debt here, but the shrink-to-grow strategy has served the business and investors well so far. Besides the divestment, Tenet’s real momentum has come from real volume growth, a solid strategy that delivers organic growth, low labor cost inflation and divestment of underperforming hospitals.

With 98 million shares trading at $153 following the impressive push, the stock has a $15 billion equity valuation or a $25 billion enterprise valuation here. This values ​​operations at about 1.2 times sales, a very reasonable multiple of 6-7 times EBITDA, as earnings power of about $10 per share yields a very acceptable multiple of 15 times earnings, very acceptable, certainly because leverage decreased a lot.

The reality is that I can only congratulate Tenet’s management for an outstanding job and step back for being too conservative at the start of the year. If the company can continue this operating performance, it looks like there’s more room for Tenet stock to continue moving forward, but I’d like to hear more about continued momentum before reconsidering a neutral but highly constructive position.