Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

Okay. Perfect. All right. So good morning, everyone. Thanks for joining us. I'm Steve Baxter, the Healthcare services analyst here at Wells Fargo. We're very pleased to have Tenet Healthcare with us this morning. As you likely know, Tenet operates a network of ASCs, acute care hospitals and a revenue cycle management business. From the company, we're happy to have CEO, Saum Sutaria; CFO, Sun Park, and Will McDowell from Investor Relations. Thanks again for being here. And I think we're going to start maybe by throwing it to Will for a cautionary statement.

Yes. Thanks, Steve. Good morning, everyone. Pleasure to be with you today. Just in the course of our conversation today, we may be making some forward-looking statements. In the context of those statements, I would suggest you refer back to our cautionary statement included in our most recent earnings release as well as recently filed SEC filings. And with that, I'll turn it over to Saum for some opening comments.

Thank you, Will, and thanks for having us. I appreciate the opportunity here today midyear, mid-Q3, really, in terms of where we are. We feel a great deal of confidence in the business. I would reiterate our earnings guidance for the year, including the raise that we put out after Q2 in both EBITDA, free cash flow and our M&A guidance for USPI. We're pleased with the way we are progressing through this year, in particular. From an operations standpoint, the margin expansion has been notable and significant, in particular, consistent with our high acuity strategy, which I'm sure that we'll get into. We're also very pleased that from a more fundamental standpoint, the balance sheet remains strong, leverage sitting just above 3x EBITDA minus NCI, which we're very happy about as we look forward. And I think as we get into a variety of things related to policy and whatnot, we're pretty engaged in those topics, I think there will be a lot to talk about from that perspective.

Okay. That's great. Yes, thank you for those comments. And if we were to kind of think about -- obviously, you had a very strong start to the year, as you mentioned, the EBITDA guidance, the free cash flow guidance have both come up a lot at this point. As we kind of separate things a little bit between maybe Medicaid supplemental payments, which are kind of a discrete item in some ways. I know that's not always how the companies would think about them, and what we'd call maybe like the core performance. How would you characterize, if we kind of strip out the moving parts on the Medicaid figures? What's gone right in the first quarter and the second quarter? What's driven the outperformance that you've seen so far year-to-date?

Yes. Well, Sun, you may want to comment on the proportion of the guidance increase, but primarily, this was on organic performance.

Yes. And like you said, we did have about 100 -- a little over $100 million of out-of-period Medicaid supplemental payments in addition to our kind of baseline that contributed to about 1/3 of the raise. But as Saum said, the majority of the raise was based on core operating performance. Strong volumes, strong acuity in the hospital space, obviously strong operating expense controls and then the same parallel facts in the USPI space as well.

Okay. That's great. And then as we look about the improved profitability you saw in the first half of the year, obviously, is a big positive. I think one thing that definitely -- I think people are trying to reconcile a little bit is the performance on volumes as we move from the first quarter into the second quarter where across the industry, and I guess you guys were no exception that volumes were a little bit weaker in the second quarter. I guess as you guys have had a chance to continue to step back and study the second quarter and the trends in the first half. Yes, I guess how would you frame the second quarter's performance and kind of what that could mean for as we think about the balance of the year?

Yes. I mean the primary framing for our second quarter was excellence in operations, right? I mean I think the important thing about our acute care business is the ability to generate earnings, or in this case, even beat our expectations in our earnings regardless of what in that window, the volume picture looked like in that quarter. And that's very important because there are 2 things related to that. And I kind of alluded to this in my opening comments. The high acuity business is less elastic, right, and less subject to demand variation. And the ability to bring that business in, protect capacity for that business in particular, helps us generate more consistent earnings, right? And that may be different than the industry at large. But for us, that's a very important component of how we generate earnings in what we're doing and also the role that we play in the communities in which we exist. So that's one piece of the puzzle. The second piece of the puzzle is just the ability to be nimble in our expense management. We demonstrated this back during COVID, in particular, with labor management during that period of time, when volumes were very, very erratic and in some ways, fluctuate from month-to-month and year-to-year with COVID. And even now, as you look at the first and second quarter, the difference between those two, our ability to drive expense management in order to generate more predictable earnings continues to be proven out. As I've said, we've now hardwired this into the enterprise in a way where we can rely on it. And so my characterization of Q2 was it was a strong quarter.

Appreciate that. And then as we -- again, I know there are obviously going to be quarter-to-quarter variations and volume trends, and I think everyone appreciates that, that followed the business for a long time. It would look like the second half of the year is expected to be a bit stronger than maybe the first half was when you look at the guidance for adjusted admissions, same-store in the hospital business. I guess, how are you guys thinking about that at this point in time? Is there any kind of discrete drivers of that, that we should kind of think about?

Yes. I mean one thing I would say is that just based upon Q2, we've not changed our demand forecast or our algorithm for how we're thinking about driving business in the second half of the year, right? I mean if anything, after Q2, of course, we went back and took a look at all of the things we could control, ER throughput left without being seen, the ability to move patients through the house, et cetera, et cetera. And our operations are solid. I don't think there was anything particular in a market or an operating parameter or anything else. And there's nothing about the demand environment that's obviously changed in one region or another to drive that. So from our perspective, we're very focused on continuing to do the things that will drive earnings including with the increased guidance that we put in for the year, which again, I would just tell you, we feel confident and reiterate today.

Okay. Great. And yes, as you mentioned in your kind of lead-in comments, like obviously, a lot of focus on policy at the moment. And -- the most near-term thing potentially in terms of the timing perspective would be the enhanced exchange subsidies and whether they're extend there. And obviously, it's very hard to predict that. But I would love to, I guess, first, just get an update on kind of where you are in the engagement process around trying to advocate for that and what you're hearing there? And then additionally, I know there's been, again, like it's a difficult item to size, I'm sure. But as you think about it, as we get closer to the actual event, what do you think the company would need to see or to be prepared to potentially actually help us think about what the exposure could look like there?

Yes. Well, let me -- let's spend a few minutes on this because I think it is the most important topic from a policy standpoint that exists in the near-term environment anyway. And I think if you think about the last time that we spoke publicly to now, the conversation, and I think many of you have noted this, has really shifted towards the importance of figuring out a pathway to extend the premium tax credits for a variety of reasons, which we'll go into in a second. But I think that shift is very positive. I think the range of outcomes has broadened, right? This used to be a discussion of yes versus no. Now it's a discussion of, yes, with what vehicles; yes, with what new terms and conditions; yes, how does it play into, what was done in the OBBB to reduce "fraud waste and abuse" within the program. But there is an increasing understanding among the majority party that this is politically very important. So I look at this two ways beyond the industry in terms of what's driving that change today. First of all, this is a private sector solution, right? We're sitting in Massachusetts, where the exchanges were actually developed by Republican Mitt Romney, which is what the Obamacare exchanges were modeled after. But there are really two things driving this from what we can see. The first is a recognition that the value of the premium tax credit to individuals below 400% of federal poverty level is equal to or, in most cases, significantly greater than the benefit of the tax relief that was provided in the OBBB. And so what does that mean? I mean in simple terms, what that means is essentially that without the extension of those credits, the talking point that the OBBB tax cuts becomes a benefit for the wealthy rather than for all citizens, actually becomes a reality if you're somebody who's sitting on the exchanges. And that's an important point in terms of the midterm elections. The second thing that's interesting and is growing in the narrative is how important these exchange premium tax credit seem to be for small businesses. So I looked at this before. I mean there are on the order of 16 million small businesses in the United States with under 50 employees, the traditional definition would be under 500. But under 50, where you don't have to statutorily provide health insurance, they employ roughly 30 million, 35 million people in the U.S. every year. And if you think about the primary federal subsidy to small business that exists today, is the small business tax credit -- the tax incentive, the QBI, right? The average small business in America turns out of that size generates no more than $100,000 in net income that's taxable. So when you take a 22% average tax rate and then take a 20% benefit on that, you're talking about a benefit of around $4,000 or $5,000. If those businesses ended up having to provide insurance coverage to their employees, that would run on the order of $8,000 to $9,000 per employee per year. So if you think about it, the exchange premium tax credits are the most significant subsidy, federal subsidy to the competitiveness and employment vehicle in small business today. And I think as you combine that with the politics, you'll see some polling work released this week from the very respective Fabrizio Award Group looking specifically at Texas and Florida that will show that the Republican backing among voters and the exchanges overlap incredibly significantly. And the #1 issue that you see in particular among small business owners which are 3x likelier than the average voter to have voted for the administration today support the extension of these credits. Why? Because of the simple math I just gave you related to how important it is to their small businesses. So I think there's momentum building in the dialogue that is helping the environment understand the importance of these premium tax credits well beyond the health care industry. And I think that's what's probably creating more momentum to continue these subsidies.

Okay. That's great. And then I guess there is a world where, obviously, it can be hard to strike these deals at times and the company will have to plan for contingencies if that's not the case. I guess, what do you think you would need to know to estimate what the potential impact would be like you could be facing a scenario where you're going to need to put out some kind of estimate about this at some point in the next few months?

Yes. I mean, well, you need to understand timing. You need to understand what's happening to the subsidies. You need to understand what enhancements and alternatives that are available, ICRA and other things could be made, in particular for small businesses. And you would probably need to have some understanding of what the moving parts and pieces will look like with respect to pricing of the products on the exchanges over time? Because there has been some discussion of regulating price increases there. And there's also been some discussion of increasing cost sharing meaning reducing out-of-pocket for consumers as a part of this policy. So I think when all of that becomes clear, which, in one way, shape or form, it's going to relatively soon, it becomes a lot easier to estimate what we think the impact of that will be.

Okay. And then to move a little bit on to the Medicaid side of things. Obviously, this year is benefiting from some of the increased Medicaid supplemental payments, which is good to see. There's been a lot of focus around whether some previously submitted applications were going to be able to get across the finish line and maybe get grandfathered in under some of the policies that we've seen with the One Big Beautiful Bill Act. I guess what's the latest thinking on the opportunity set there in front of the company? Is that still something that you think of as a material potential contributor over the next couple of years before we start to think about any of the provisions that start in 2028? Or I guess like is there a different thought process...

Well, I think three things. One is, listen, I mean, first of all, all of our guidance has assumed none of the new programs other than that Tennessee piece were approved, right? And I think we've been clear about that again and again. So anything that does get approved that's going to increase these programs potentially from the applications submitted, will only be a net benefit even beyond what we've already done for the year in terms of our guidance. And I think it also lays the foundation or a new baseline going forward. Now it seems like we're seeing feedback and approvals and back and forth, we've certainly heard about a lot of back and forth between CMS and the state of Florida around their submission. We have and you guys have seen the reports, Texas that appears to have -- or be close to a confirmation of an increased program size. So it feels like this is moving forward, from the perspective of CMS taking and sorting through all of these various applications. And if, in fact, the trend line continues, this looks like it could be a potential benefit to the baseline. Look, the other thing I would say is that the components of the OBBB that touch Medicaid state directed payment programs have been pushed out all the way into the early part -- well, really the end -- very end of '27 and early '28. And it's really hard to tell what's going to be implemented and actually executed on at that point. So we're not doing a whole lot of planning from that purpose. One thing I would reiterate, in our market where there is a significant Medicaid population to take care of, including with some of the supplemental payment increases that we have seen that we reported as "onetime items," many of those are based upon work we do organically to grow that business, right? At our cost structure, we welcome this business into our hospitals. And some of the increases that we see in these state-directed payment programs are based upon our work, our services, our receiving high acuity Medicaid transfers that is based upon actual growth of the business and then growth in our market share, of course, of those payments. And we expect to continue doing that and executing upon that as we go forward.

Okay. And then just on the hospital, I guess, capital side of things, the company has created a lot of value through asset sales over the past few years. Do you feel like at this point in time, you've executed on the possible there, and you now have the right set of assets in the hospital business? Or do you think there's potential for more of this over the next several years?

Yes. I mean I always answer this question the same way after every asset sale we did, I said I was happy with the portfolio, right? So we're happy with the portfolio, and we'll leave it at that.

Okay. And then if we think about capital and the improved free cash flow profile of the company, it seems like you have much larger ability to invest than maybe the company has had historically. And I think as we look at -- try to benchmark maybe CapEx as a percentage of revenue and kind of compare that across the peer set. I think one thing that investors maybe have struggled with historically is kind of contrast in the company's commitment to the high acuity strategy and maybe what can be perceived as like a lower level of capital investment. Now that you have more ability to invest, do you think you have the right amount of hospital CapEx? Or do you think there's more opportunity to deploy CapEx over the next few years into the business?

Well, I mean, to answer the question directly, and then maybe you could talk a little bit about the numbers. I don't -- I think the -- the folks that know the company, you say investors, but investors, analysts that know the company, know that very clearly over the last 6 or 7 years, we've taken market share, increased profitability, significantly improved return on invested capital, expanded capacity, opened multiple new hospitals with whatever you're calling the metric of CapEx per bed. So I'm not sure how to answer the question of there's concern. I think demonstrably, the business has improved significantly with the CapEx per bed that we are spending. I will say that one of the nice things about the divestiture program is that we were able to divest markets where we didn't think the return on invested capital would be as good going forward in our business model. That may not be true for the folks who picked up the assets. And so for us, if you look at our capital expenditure, despite having sold at roughly $5-ish billion of revenue in that business, the CapEx is actually up. So the CapEx per bed is going up with the portfolio that we feel comfortable with investing for the future.

And I add a couple of more points. Looking back, obviously, in '24, we spent more CapEx than we did in '23 despite the divestitures that happened in '24, just as an example, that's number one. Number two, if you look at our overall enterprise, right, Conifer and USPI are very capital efficient, right? So if you look at percent of revenues, as [indiscernible] you're talking about, we have to focus on the hospital piece, where the vast majority of our CapEx dollars go. And then as we look forward, it's tough to kind of compare dollars to dollars over a year. There are the divestitures. We've also had several big hospital builds that we've completed over the last 3, 4 years. And then going forward, I think the most important point is, we still believe our portfolio, to Saum's point, is very investable, number one. And number two, to the extent we dial up or dial down our CapEx investment in any particular year. We have the cash flow and the balance sheet capability to dial that for the right return and the right optimization profile versus having to debate availability.