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August 05, 2020 05:03 PM

Government funds, expense cuts behind for-profit hospitals' Q2 profit growth

Tara Bannow
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    Despite more than a month-long suspension in high-margin surgeries due to the pandemic, the country's four largest investor-owned hospital chains managed to increase their cumulative profit 69% during the second quarter to $1.5 billion, surprising analysts and others who follow the industry.

    The higher profits were largely due to the combined $2 billion in federal stimulus grants the four companies, HCA Healthcare, Community Health Systems, Tenet Healthcare Corp. and Universal Health Services, recorded during the quarter that ended June 30, money they don't have to repay. If not for those grants, some of the companies may have lost money in the quarter without more significant operating changes.

    But there was another big factor that drove profitability: aggressive cost cuts. The four companies slashed expenses to a greater extent and faster than anyone expected, by a total of 16% year-over-year. In an industry known for its high fixed costs, that's a rarity.

    "It's a little surprising, the scale to which they were able to lower their expenses," Sarah James, senior research analyst with Piper Sandler, said of the companies' results.

    Part of that was from not having to buy big-ticket items like hip or knee implants involved in surgeries, as well as other materials used during procedures. Elective procedures were shut down from mid- to late March until May or even June in some areas. Not only are hospitals not paying for supplies associated with their regular procedures, the government is also reimbursing them for the costs of caring for COVID-19 patients, which creates an inflated margin, said Martin McGahan, a managing director in Alvarez & Marsal's healthcare industry group.

    "You're actually getting a little bit of a double lift," he said.

    On the labor side, hospitals early in the pandemic announced furloughs, layoffs and temporary salary reductions and retirement pay suspensions. Even where that wasn't happening, hours were flexed down in areas that were shut down or seeing lower volumes. Brett Brodnax, CEO of Dallas-based Tenet's ambulatory subsidiary, United Surgical Partners International, explained on a recent earnings call that when the pandemic hit, the company quickly flexed down hours by about 65%.

    During a pandemic, employees are more willing to accept those kinds of changes, which would typically be unpopular, said Brian Tanquilut, healthcare equity analyst, Jefferies.

    "It seems like it was easier to push through and not get much pushback than it would have been in a different situation," he said.

    For-profit hospitals certainly proved themselves to be more resilient than Wall Street analysts expected, said Matthew Gillmor, senior research analyst with Baird. Now the question becomes: How much of these cost reductions will stick, and how much is just short term? Tenet, for its part, said this week its cost reduction measures—and their positive impact on margins—are permanent.

    Another factor that drove profitability was the quicker-than-expected bounce back in patient volumes in May and June. Not only that, Gillmor said the patients who returned for services tended to be higher acuity carried commercial insurance at higher rates than analysts expected.

    Tenet said its ambulatory surgery center visits were at 94% of their pre-COVID levels in July, and hospital admissions were at 90%. Nashville-based HCA even reported higher ambulatory surgeries and same-facility inpatient surgeries in June compared with a year earlier, and a higher proportion of the company's admissions were among commercially insured patients.

    It's unclear how long that will last, though. Beginning in July, Piper Sandler's patient surveys have begun to show increased reluctance to return for procedures as coronavirus cases have picked up in some regions, James said.

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