Universal Health Services, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 3/5

Universal Health Services, Inc. operates acute care hospitals and behavioral health facilities, primarily located in the US and UK.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Universal Health Services (UHS) operates a diverse healthcare business, with a focus on both acute care and behavioral health services. It operates hospitals and other facilities across 39 U.S. states, Washington D.C., the U.K., and Puerto Rico. Here’s a breakdown of its key segments:

Acute Care Hospitals: These facilities provide a broad range of medical and surgical services, including cardiac care, surgery, and diagnostic imaging.
Behavioral Health Facilities: These facilities offer mental health and substance abuse treatment services, including inpatient and outpatient care.
UHS manages over 360 facilities with about 90,000 employees. The company has made acquisitions in the last few years, including the acquisition of an additional interest in the Valley Health System.
The Company generates revenues from patient service charges, premium revenues, capitated and contracted revenues, and other revenues related to healthcare operations, including through the federal and state governments through Medicare and Medicaid programs and commercial payers.
UHS’s revenues are somewhat diversified across service lines.
UHS is a very large operator in its industry.
The revenue mix has been relatively stable over the last few years, with patient service revenues accounting for over 90 percent of the business.

Industry Trends:

The healthcare industry is currently experiencing strong growth because of an aging population and increases in government spending.

Rising Healthcare Costs: The industry is facing rising costs of care, which is creating challenges for many providers, especially those with high debt levels.
Government Regulation: The healthcare industry is subject to extensive government regulation, and changes in regulation may have a significant impact on providers’ profitability. It is currently being regulated by CMS under the ACA/Affordable Care Act.
Technological Advancement: Technological advancements are creating both opportunities and threats. These new technologies are allowing for new approaches to patient care but are also increasing the costs of operation in a competitive environment.
Consolidation: The industry is seeing consolidations of large providers. This can help drive down the costs of services but also increase the competitive pressures within local areas.

Margins and Profitability:

UHS demonstrates modest profitability, although its return on invested capital has been below the median for the past few years. Here’s a more detailed view of margins:

Operating Margin: UHS’s operating margin is between 13-15 percent over the long term. It has recently declined after the acquisition of another large hospital chain.
ROIC: UHS’s Return on Invested Capital has been relatively stable over the past decade, falling within the 7 to 12% range when including goodwill in the calculation and 12 to 15% range without including it. The return on invested capital is a crucial measure to assess a company’s value creation.

Competitive Landscape:

The healthcare industry is highly competitive and fragmented with a mix of:

For-profit hospital chains: These are typically large publicly traded companies such as HCA Healthcare and Tenet Healthcare that are mainly focused on urban areas.
Nonprofit hospital systems: These include many individual and large systems and may be affiliated with teaching hospitals or community hospitals. They are generally non-profit and reinvest profits.
Local and regional hospitals: These independent hospitals are usually smaller and focused on a specific area and population.
Behavioral Health Providers: These providers tend to operate smaller facilities across a region, and provide care for patients with mental health problems.
UHS competes with other large national hospital chains as well as local and regional operators. In behavioral health they compete with a variety of local and for-profit operations.

What Makes UHS Different?

Diversified Portfolio: The company’s emphasis on both acute and behavioral health services can be seen as an asset, as that can help mitigate revenue losses that may come from a downturn in a particular sector.
National Presence: The Company’s large operation provides it significant pricing power and a significant barrier to entry.

Financials (In-Depth Analysis):

UHS’s financial statements reveal a mix of strengths and weaknesses that affect its valuation:

Revenue Growth: Revenue has grown consistently over the last decade, primarily driven by the company’s expanding network of facilities and acquisitions. Recent revenue numbers however, have stagnated and even slightly contracted. For the nine months ended September 30, 2023, net revenues increased by 5.8% compared to the same period in 2022. A significant portion of this growth was from their acquisition and increased revenue per hospital.
Profitability: The company has historically shown stable profitability but that margin has declined over the last few years, as a result of increasing operating expenses, interest, and taxes. For the nine months ended September 30, 2023, operating income increased by 22.8%, from $1.1B in 2022 to $1.4B in 2023. Meanwhile, net income increased from $664m to $772m in the same period. This has led to a return to pre-covid profitability with improving returns. However, the ROIC declined significantly from the 2021 mark.
Cash Flow Generation: UHS has strong cash flow generation, which is used to grow its business. Cash from operating activities is positive and significant. But the company is also spending a great deal of cash on investments and acquisitions, meaning free cash flow isn’t as high as it could be. In the first nine months of 2023, cash flows from operations were significantly lower at $535m, vs the $1.1b in the same period of 2022. This was also impacted by the timing of payments of certain items. While it is generating strong cash flow from operating activities, it’s not free to be spent due to the need to service debt.
Debt Levels: UHS has significant debt obligations on its balance sheet, mostly comprised of long term debt. Their debt to capital ratio at 51.2%, a higher rate of debt than a traditionally profitable company. Servicing of this debt and the high interest rates of a highly indebted company makes future earnings estimates more uncertain.

Recent Concerns/Controversies & Management Commentary:

Impact of Medicare/Medicaid Changes: Medicare/Medicaid are a significant source of revenue for healthcare providers, including UHS. They are also often the target of regulatory changes. There are several new regulations that will likely affect the company over the next year. In addition, these changes might reduce their operating revenues and margins.
Labor Shortages: The company has struggled with increased labor costs and staffing shortages, which could reduce the company’s profit margins in the next few years.
Interest Rate Hikes: Rising interest rates could increase the company’s debt costs, putting a further strain on profitability. The company is heavily leveraged, with a debt/equity ratio of over 1, this will increase the company’s risk of default if interest rates continue to rise.
Impact of COVID-19 Although the company has fully recovered from the effects of COVID-19 in terms of demand, the company had to write off a sizable portion of revenue that was due to various COVID measures. The company is now focusing on making sure they are compliant with government guidance surrounding their industry.

Moat Analysis:

UHS possesses a narrow economic moat, with its wide scale and its market position, particularly in behavioral health facilities. However, that is partially offset by:

Intangible Assets: UHS operates in a space that benefits from the strength of its brand, especially in the local areas that they dominate. Their size and recognition provides a competitive advantage. But those are not really high-barrier-to-entry type moats and can be challenged or eroded as new healthcare models become popular.
Scale/Cost Advantages: While a larger scale often leads to advantages, these are only relevant in certain industries, or within the same geographic area. There are lots of examples of small efficient hospitals that are able to provide services at costs that are equal to or lower than larger chains. So, the scale doesn’t provide too much advantage in this case.
Barriers to Entry: UHS has a track record of navigating regulatory complexities in healthcare. However, these regulations do not hinder new or smaller players in the market, meaning that regulations are not a moat.
Switching Costs: Customer loyalty tends to be higher in smaller local markets or through personal relationships with individual doctors/physicians. Therefore, the ability for UHS to retain its customers by making it difficult or costly for them to switch providers is limited.

Overall, these factors lead to a rating of 3 out of 5 for economic moat.

Risks to the Moat and Business Resilience: While UHS does have a moat, several risks could erode them. There may be a limit to how much pricing increases that customers are willing to bear.

Regulatory and Legal Changes: As a company which operates in the healthcare sector, any new changes that are imposed by government entities could hurt the company’s revenue.
Cost Increases: Rising labor costs, and rising inflation, are big threats to profitability. These factors have the potential to weaken the margins and therefore the financial advantages from cost leadership.
Competition from New Technology: In the future, there is a possibility that new companies can come in and provide a better experience for patients. This can disrupt the industry as a whole and negatively impact more traditional healthcare providers like UHS.
Leverage/High Debt Burden: Due to high debt and the changing interest environment, the company could see significant reductions in their net profit and profitability if they do not manage the capital structure correctly.

The resilience of the business is moderate. It has a solid track record, but is operating in a competitive market environment with high regulation. Given how long they have been doing business and the experience of the managers it is more likely they will overcome their present difficulties. However, due to the low switching costs, it is very easy for new competitors or better funded companies to erode its market share.

Understandability Rating: 3/5

UHS is relatively easy to understand. It operates a mix of hospitals and behavioral health facilities. Valuing the business, however, can be complex due to acquisitions and multiple streams of revenue. Its large scale and diversified revenue stream adds to the difficulty of accurately modeling all of the components into a valuation and can be difficult to grasp.

Balance Sheet Health Rating: 3/5

UHS’s balance sheet is relatively healthy, but there are a few considerations. Specifically:

Leverage: UHS’s high leverage is a threat and a risk. They have a lot of long term and short term debt that may need to be refinanced.
Capital Intensive: The company has to spend a lot of capital to sustain its business model and growth.
Good Current Ratio: They have a reasonable current ratio to withstand the current market. Overall, these factors lead to a rating of 3 out of 5 for its balance sheet.