No pain, no gain. That's what Robert Muller is betting.
After the financial bruising that lower-rated hospitals took in 1998, the J.P. Morgan Securities analyst expects management to return to the ring, dukes up.
Muller has been tracking the financial performance of hospitals rated A- and lower since 1994 and reporting the results in quarterly editions of his Municipal market monitor. And although his 35-hospital sample stumbled in the first half of 1998 and is expected to show equally troubling results in the second-half report due out in April, he holds out hope for a better 1999.
"For one thing, good management does have the capability to change," Muller writes. "It just takes more than a few quarters to diagnose the problems and develop remedies and solutions."
Sample hospitals, which Muller does not identify by name, took quite a whipping in the second quarter ended June 30, 1998. After dancing in the 5.5% to 6% range in previous quarters, median net income as a percentage of revenues hit a thud-producing 4.1%. That's comparable with the lowest quarterly results posted by lower-rated hospitals in 1993 and 1994.
Muller says the one-two punch of managed care and Medicare revenue reductions certainly forced many hospitals to the mat. Meanwhile, inflation, utilization and labor costs nudged hospital expenses up by roughly 1.5 percentage points to a median 3.5% for the year, he says. And although some lower-rated hospitals in Muller's sample posted losses on physician practices, many smaller facilities never had the cash to invest in that questionable strategy in the first place.
Some causes of the drag on hospital performance are easier to rectify than others. "Costs and employees can be reduced; some unprofitable services can be closed," Muller writes. Yet longer-term questions about strategy and market position remain. Lower-rated hospitals, which generally hold weaker positions in their respective markets, must either build brand identification or become bigger players with tight cost controls.
As lower-rated hospitals ponder their weaker position and plot strategy, Muller expects to see an uptick in sales of non-strategic assets, such as nursing homes, home health agencies and managed-care plans, and a re-emphasis on core strengths.
"The last several years have been the age of mergers, and the next several years will be the age of divestitures," he says.
He also expects a strong emphasis on capping losses through productivity improvements and overhead reductions, for instance.
Meanwhile, he is encouraging bond buyers to sit tight. "We've really had three wonderful years of healthcare," he says of the 1995-1997 period. When investors want to dump healthcare, "I think you have to give management the benefit of the doubt." However, Muller warns, investors could sour on healthcare bonds if providers fail to take appropriate action.
Last year's bankruptcy of Allegheny Health, Education and Research Foundation's Philadelphia operations helped widen the spread between AAA-rated debt and lower-rated hospitals by at least 25 basis points, Muller said.
"If we have a repeat of '98, (investors) have to begin to worry about how much healthcare exposure (they) have."