HCA Retains Narrow Moat as Pressures Begin to Ease on Providers

Senior Equity Analyst

Julie Utterback

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HCA Healthcare operates the largest network of hospitals in the United States, focusing on attractive geographic locations where it has the potential for leading and increasing market share. With headquarters in Nashville and locations in 20 states and England, its facilities are particularly concentrated in Texas and Florida, which represent over half of its bed count. In those states, urban areas of focus include Dallas, Austin, Tampa, and Miami; those geographic areas provide a good sense of the positive demographic factors that the firm aims to benefit from across the country.

Within its target markets, HCA aims to expand share through a variety of strategies to attract patients, physicians, and third-party payers. The company provides wide networks of facilities in its chosen geographic markets with key hospital anchors supported by ambulatory surgical centers, urgent-care centers, and physician clinics at convenient access points. HCA aims to be the facility of choice for physicians who are typically free agents with practicing rights to other hospitals in the area. For example, HCA has spent the past decade or so investing in its surgical suites to improve efficiency, nursing, and technology offerings to appeal to surgeons scheduling those procedures and positively influence patient satisfaction, which builds on the reputation of HCA's facilities. From a payer standpoint, HCA continues to contract with health insurers in roughly three-year cycles, which is typically manageable but has caused some concerns in recent years as healthcare labor costs have risen. 

Overall though, HCA's strategies have generally yielded positive results over the long run, including market share gains and some of the most efficient and profitable operations in the industry. In the long run, we expect the firm to increase its top line in the midsingle digits and earnings per share in the low double digits.

Business Strategy & Outlook

As the largest hospital operator in the U.S., HCA has amassed enough cost advantages to maintain economic profits for at least the next 10 years, in our opinion. The company typically generates returns on invested capital in the high teens, well above its capital costs, and we expect similar economic profitability to continue during most of our explicit 10-year forecast. 

Like politics, healthcare services are local, and HCA enjoys significant share in each of its target markets. On a consolidated basis, its local market share stood around 27% at the end of 2022, up from 23% in 2011, and patients, physicians, and payers are increasingly seeking out this organization’s services. With that significant and growing share, HCA can negotiate reasonable rates with key health insurers in those local markets. Commercial insurers represented about 30% of inpatient admissions and 48% of total revenue in 2022, as HCA earns more on those patients than on government-based programs. Overall, revenue per equivalent admission, a proxy for pricing, has grown 4% on average during the past 10 years. We expect HCA to enjoy similar low- to mid-single-digit pricing power during the next 10 years in our base-case scenario, which should help it generate economic profits.

While the company's local-scale related advantages are important, we think another substantial part of HCA’s maintainable competitive advantages are its cost advantages. The company uses analytics from its industry-leading healthcare services database to spread best practices across its network of facilities, which appears to have quality effects and cost-related efficiencies that help HCA achieve top-tier profitability in the hospital space. Based on our calculations and data from the American Hospital Association, HCA’s cost structure is typically 10%-15% lower than the average U.S. hospital, which appears to be the most important factor in HCA’s much higher (about 800 basis points) operating profitability than the average U.S. hospital.

Within its services, management uses its extensive database to identify best practices in terms of quality and cost throughout its operations, which helps the firm maintain a cost advantage, in our opinion. HCA systematically pushes out those best practices throughout its network of facilities to boost productivity. Obviously, quality of care needs to be high, but these more efficient operations can also lead to greater patient, payer, and physician satisfaction, too. For example, HCA’s average length of stay is about 10% lower than the average U.S. hospital, which can equate to about half a day less in the hospital per patient. That efficiency can positively influence payer satisfaction with HCA’s services, too, as they are likely saving the payer money by reducing the overall hospital day charges. Physicians can also benefit from HCA’s more efficient scheduling processes for surgical cases, for example, that can have a direct impact on the income generation of each physician. Also, while much of the company’s cost structure is fixed, some major cost inputs, such as labor, have a significant variable component that can be managed through analytical capabilities. For example, HCA pays out nearly half of its revenue in labor-related costs, and since only about half of those costs are fixed, the company can positively influence its profitability by managing the remaining variable labor costs more efficiently through its analytical capabilities. Additionally, we believe part of HCA’s cost advantage relates to its negotiation for supplies through its own top-tier group purchasing organization subsidiary.

Narrow

Economic Moat

HCA Healthcare

HCA Healthcare, Inc. is a health care services company engaged in operating hospitals, freestanding surgery centers and emergency care facilities, urgent care facilities, walk-in clinics, diagnostic and imaging centers, radiation and oncology therapy centers, comprehensive rehabilitation and physical therapy centers, physician practices, home health, hospice, outpatient physical therapy home and community-based services providers, and various other facilities. The firm operates general and acute care hospitals that offer medical and surgical services, including inpatient care, intensive care, cardiac care, diagnostic, and emergency services, and outpatient services, such as outpatient surgery, laboratory, radiology, respiratory therapy, cardiology, and physical therapy. The company was founded by Dr. Thomas F. Frist, Jr in 1968 and is headquartered in Nashville, TN.

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