An Upgrade for Undervalued HCA Healthcare

Jake Strole: We've taken a fresh look at the U.S. acute care industry and have come away a bit more constructive in our outlook, particularly in regard to HCA Healthcare. We think the firm has been able to dig a narrow economic moat underpinned by scale-based advantages that make the company one of the most efficient operators in the space.

HCA is the largest hospital system in the country and is expected to generate over $45 billion in net revenue during 2018. While this accounts for roughly 5% of hospital expenditures nationally, we think the competitive dynamic is best analyzed at the local level, rather than at the national or even state level. Though this lens HCA's competitive advantage becomes clear, as the firm boasts a consolidated 25% market share when measured against its direct competitors. HCA is the leader in many of these geographies, reporting market shares that eclipse 35% in its largest markets. As a result, the firm can wield pricing power, frequently earning 4% to 5% annual reimbursement updates from commercial payers, which account for over half of the company's sales.

The firm's scale also results in benefits on the cost side of the profit equation, aided by its ownership of the third largest national group purchasing organization. The nearly $7.5 billion the company spends annually on supplies allows it to earn additional pricing concessions from vendors. HCA reports the highest margins in the industry, illustrating both its strong market position and efficient operations.

Concurrent with our moat upgrade, we've raised our fair value estimate to $114 per share. We believe the market is likely underestimating the durability of HCA's competitive advantages and the ability for management to create value through effective capital deployment over time. We think shares are attractive at current market prices and encourage investors consider an investment in this narrow-moat enterprise.