Is a $1 stock worth the risk?
Hospital operator Tenet Healthcare is dirt-cheap right now, but there may be a perfectly good reason for that.
NEW YORK (Fortune) -- The cheapest stock in the S&P 500 isn't a financial services company or an automaker - it's Tenet Healthcare, which owns and operates about fifty hospitals nationwide. Despite offering a seemingly recession-proof service, Tenet's stock dropped 78% in 2008, and shares have traded close to $1 apiece since November.
To bargain-hunters, Tenet (THC, Fortune 500) looks like a potential gem. If you buy now and its shares rise by a buck, you'll essentially double your returns. But is the stock a true value play, or is there a good reason why it's at the bottom of the barrel?
The downside of a $1 stock is limited - the company's shares can only dip by pennies. Beyond that, there's the threat of Chapter 11, but most analysts don't foresee that in Tenet's near future. "The likelihood of bankruptcy in the next few years - there's no chance," says Sheryl Skolnick of CRT Capital. "There isn't a catalyst for it to happen."
While Tenet currently owes $4.8 billion, slightly more than half of its total assets, none of that debt matures until 2011. The company has negative free cash flow, but it can tap a revolving credit facility of $500 million. Robert Hawkins, a Stifel Nicolaus analyst, projects that Tenet could sell about $700 million worth of medical real estate soon.
Another sign of Tenet's solvency is the price of its debt, which is more expensive than similar corporate bonds on the market; the bonds' relatively low yields imply that investors don't anticipate defaults from the issuer. "The smart debt guys don't believe that Tenet is going bankrupt," says Hawkins.
But even if Tenet is safe, there's little to be gained from its stock unless the company has visible upsides. Along with the rest of the for-profit hospital industry, Tenet faces severe macroeconomic challenges - a tough spot for a company with a thin wallet.
"It's not a good environment in which to be highly leveraged and burning cash," says Jason Gurda, an analyst at Leerink Swann.
Seven years ago, Tenet was trading in the mid-sixties and earning an annual profit of $800 million on $13 billion in revenue. Then, in late 2002, investigators alleged that the Dallas-based company was overpricing its services to the Medicare program.
Tenet's stock burst, dropping to $16 by the end of the year. Its scandalized management resigned, and Tenet installed a new CEO, Trevor Fetter, in 2003.
Fetter has since attempted a turnaround - even buying 100,000 (admittedly inexpensive) shares in November -but Tenet has struggled to regain its financial health. The company paid hefty settlements, including $725 million in 2006 for price gouging. Ever since 2002, Tenet has posted consistent annual losses.
Tenet finally began to show signs of life in the beginning of 2008, reporting in the third quarter that same hospital admissions had increased by 1.7%, compared with a slight decline in the previous year.
The company also recruited 900 new physicians - proof that it had mended its relationship with the medical community. "If you predicted a few years ago that this company would recruit that many physicians in a year, you would have been laughed at," says Skolnick. "Tenet is executing better."
But just as Tenet's condition was improving, the credit crunch hit - and brought the stock back to its knees. "Because Tenet was so highly leveraged, it was crushed at the beginning of the crisis," says Gurda of Leerink Swann.
As of November, shares of highly leveraged hospital companies had fallen 66% since August, compared with a drop of 44% for their less-indebted peers, according to Stifel Nicolaus' Hawkins. "The sad news is, Tenet is probably operating at the highest quality of any for-profit operator," he says.
While Tenet's performance last year demonstrated clear improvement, the market had no tolerance for leverage - and may not look kindly upon high debt ratios for a while.
Many of the challenges that Tenet faces are endemic to the hospital industry at large. Tenet's whopping 99% debt to assets ratio, or its total liabilities divided by all that it owns, is the worst its class, but its peers are hurting too - the industry average is about 50%.
According to Charlie Whelan, director of health-care consulting at Frost and Sullivan, the hospital industry's debt problem is largely due to a decline in reimbursements, the fees that doctors receive from government programs such as Medicare and commercial providers. "With each passing month, more Americans are uninsured, and hospitals are picking up the tab," says Whelan.
The current economic crisis is increasing that bill, as more workers are unemployed - and uninsured. Nearly half of the hospitals responding to a recent Longbow Research survey said admissions declined in the fourth quarter while 24% reported declines in commercially insured patients, the highest-paying customers for hospitals.
One potential salve is the new administration's promise of universal health care, which would boost the number of paying patients manifold. But the Obama factor, says Gurda, won't be immediate. "Even if the legislation is passed this year, it will take another year or two to implement."
Although Tenet's overall volume increased last quarter, its admissions of patients with commercially managed care dropped 3.4%. When Hawkins heard that figure, he dropped his 2009 earnings estimate to 9 cents per share. (The Thomson Reuters analyst consensus is 1 cent per share). "Unless we get meaningful coverage of the uninsured, you can't help but see that these guys are going to lose," he says.
As for-profit hospitals fight for survival, geography will play a big role in determining who succeeds. Companies in unemployment-ravaged regions and poorer cities draw fewer paying patients. Tenet, with its many Southern and urban locations, faces a severe disadvantage.
"They have a great reputation now, but, because of where they are, they get every patient that doesn't pay," says Hawkins. The analyst, who used to sell urban hospitals for a living, says it's difficult for private operators to compete with government-supported nonprofit hospitals in cities.
Not all for-profit hospital chains face the same structural issues; Community Health Systems, an analyst-favorite, focuses on rural areas with less competition. But Hawkins admits that he's bearish towards the sector in general. "There are many more attractive health care industries out there, like big-cap pharma and biotech," he says.
Hawkins doesn't believe that Tenet's situation is hopeless; he predicts that the stock may start improving once the credit markets improve. But, much like a recovering patient, the company's precarious condition makes it more susceptible to the adverse financial environment - and less likely to recover.
For now, it's the cheapest stock around, but that doesn't mean it's a bargain. 
-
Loudmouth CEOs and dead celebrities. Our annual list of business's bonehead plays marches on. More -
PBR has made a comeback during the downturn, becoming the hipster's cheap beer of choice. More -
With uncertainty at a high, we sought the advice of some of the smartest market watchers we know. More -
Take the stress out of holiday shopping with our picks for the tech geeks on your list. More -
IBM, led by CEO Samuel Palmisano, takes the top spot of best businesses for nurturing talent. More -
Most books on Apple's CEO come in one of three genres: Hero, Creep or Creepy Genius. More
