uploads/2014/12/Graph-2021.png

Why Universal Health Services deserves a higher valuation

By

Updated

Comparing valuation

Healthcare companies, represented by the Healthcare Select Sector SPDR ETF (XLV), are generally analyzed using the forward enterprise value to earnings before interest, tax, depreciation, and amortization (or EV/EBITDA) multiple.

The graph above shows that Universal Health Services (UHS) traded between a 4.4x and 8.4x EV/EBITDA since April 2011. From January 2014, Universal Health Services (UHS) has traded higher than HCA Holdings (HCA),  Tenet Healthcare (THC), and Community Health Systems (CYH).

Article continues below advertisement

Tracking fundamentals

You can explain the difference between the valuations through the difference in the companies’ returns and risk profiles.

HCA Holdings surpassed Universal Health Services in its EBITDA margins, yet it has lower valuations. This is due to the diversified business model of Universal Health Services, comprising acute care services and behavioral health services.

Other for-profit hospital operators, which are mainly in the acute care services segment, have realized Affordable Care Act (or ACA) benefits. Medicaid expansion and health insurance marketplaces led to an increase in the level of the insured population, which ultimately boosted the volumes in the acute care business.

The final rule of the Mental Health Parity and Addiction Equity Act of 2008—applicable to insurers providing medical, surgical, and mental insurance—was announced in November 2013. The act requires that parity or equality should exist in health insurance plans for both physical and mental insurance in the context of premiums, annual dollar limits, and aggregate lifetime benefits.

Since open enrollment for the 2014 period mandated for purchasing health insurance plan on exchanges started on October 1, 2013, many healthcare plans couldn’t incorporate the changes of the law. However, as the act makes it mandatory to include these changes by January 2015, healthcare plans sold in the open enrollment period for 2015 are expected to attract more people with mental ailments. So Universal Health Services should realize the benefits of the ACA in late 2014 or early 2015, pushing up forward stock valuations.

Advertisement

More From Market Realist