Universal Health Services, Inc. (UHS) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. It's a pleasure to have Steve Filton, the Chief Financial Officer of Universal Health Services, with us this afternoon. Before we get into Q&A, I just have a disclaimer I have to read. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

Steve, thank you for being here this afternoon. Some questions here that have already come in. What lessons has UHS learned from the pandemic? What in terms of thinking about how you deal with COVID-19, staffing, the layout of your facilities, et cetera, what lessons have been learned thus far?

Yes. So look, I think in terms of enduring lessons, it's tough because I think a lot of what we've learned are specific to the virus itself and the pandemic, and we certainly, and again, I'm not a clinician, but we've, I think, become much more clinically adapt at treating patients who have COVID, et cetera. I think what we've learned in a broader sense is we've got to have alternatives to people who are unable to access the system in traditional ways. So if you think back to March and April of 2020 when the pandemic first began, and people really were kind of pretty much hunkered down in their homes for the most part, the question was, how do you get people who are in distress, whether that's physical or mental, the proper care that they need. And obviously, what we've done to a significant degree, is stand up our telehealth capabilities in both acute and behavioral, particularly in physician offices on the acute side and in our own behavioral facilities on the behavioral side. I mean, obviously, as the pandemic has eased, I think there are a significant number of people who are more comfortable getting back in-person. And in fact, in our acute care hospitals, our ER volumes are back to where they were prepandemic. But for those people who really prefer a telehealth option, I think that's certainly available to them. Now again, at the end of the day, I think fundamentally, our business really takes place after that initial assessment. So somebody talks to a telehealth representative and suggest that they're having a certain kind of physical pain or a mental distress, and now they're directed to another level of care, and I think that's generally where our hospitals are going to enter. But I think that's the biggest piece of it is that to the degree that people are uncomfortable either in the pandemic or, quite frankly, in the future, accessing the system in more traditional ways, hospital emergency rooms, physician offices, community mental health clinics and want to do it in a different way that is more virtual that we've learned how to accommodate that.

Great. Thank you. And obviously, the Delta variant has shown up here, particularly in the South over the last few months. Have you seen any impact yet from any locale, states anything in terms of saying, okay, in terms of surgeries, inpatient surgeries, outpatient surgeries you need to cease or you need to slow down. Any impact thus far on that type of volume?

Yes. So it's really been interesting in this latest surge, and I think this is at least counterintuitive to many people, and honestly, maybe to me as well. We're finding a bigger impact on the behavioral business than on the acute business because I think while we're experiencing the acute business in this latest surge is, as you've suggested, not only in the South, but pretty much across all of our facilities, an elevated level of COVID patients as we have in all surges, but what's interestingly not happening in this most recent surge in our acute care hospitals, is a diminution in our non-COVID business. So again, returning to '20 -- April -- March, April 2020, we saw an elevated level, nothing like what we're seeing today of COVID patients. But what was really impacting the acute care hospitals was a 2/3 decline in surgical volumes, a 50% decline in ER volumes. Today, July, August, now into September, while we've seen a significantly elevated level of COVID patients, our ER traffic, our surgical volumes are pretty much generally hanging in at their prepandemic levels. And so for the acute hospitals in our acute portfolio, we're really seeing financial results that are outperforming our expectations because we've got all the COVID business, it's high acuity, high revenue, et cetera, but we're not seeing that crowding out impact that we've seen in previous surges. So the acute hospitals are really outperforming our expectations. On the behavioral side, however, we're seeing certain challenges that are unique, I think, to the behavioral setting. One is having COVID patients in a behavioral hospital is sort of much more limiting. When we get a COVID patient or 2 on a 20 or 25 bed behavioral unit, we wind up, I think, practically or effectively closing the remaining beds to any non-COVID patients. And so that becomes very inefficient. And then I think the other issue, obviously, is we're also, as we've talked about many times before, experiencing some pretty significant labor shortages. Some of those labor shortages are driven by the virus itself. If we're in a market where there's an elevated level of COVID cases, we are generally going to have some number of nurses or other employees who are out sick with the virus or out sick meaning quarantine because they've been exposed to the virus, even if they haven't tested positive. And then we also have a lot of nurses in particular chasing what I describe as premium COVID dollars. So -- and again, I think this is a more prevalent sort of dynamic in this surge than in any previous surge because so many more of our nurses are vaccinated and are willing to take that risk. So a year ago, if a nurse was offered the opportunity to make $10,000 a week working in a COVID unit, if they were unvaccinated they might not have taken that risk. But vaccinated a year later, I think we're finding that a lot more nurses are willing to take that risk. And to be perfectly candid, I'm not sure I could blame them. I mean we've got nurses who are literally getting 400 to 500x -- 400% to 500% of their base salary to work in an acute care setting, maybe a COVID unit, maybe just an ICU. And honestly, the hospitals that are hiring them to do this are training them, retraining them, et cetera. So it's really a pretty -- almost for some nurses who are willing to travel or do whatever, kind of an offer that's almost difficult to refuse.

Exactly. Well yes, it's interesting. We got a question over the audience about labor pressures, particularly nursing costs. So have you had to, in any of your markets, either acute or behavioral, to do things sort of sign-on bonuses or retention bonuses, anything beyond wage increases to attract nursing personnel?

So it really varies by market. And I think effectively, we're just responding to whatever the market -- the competitive pressures in the market are. So yes, so the answer is kind of all of the above, we're offering sign-on bonuses, we're offering educational loans or loan forgiveness for college loans, that sort of thing, if that's what the market is bearing. So it's all of the above. The interesting thing, again, is on the acute side, we're paying a lot of those premium dollars. We're paying overtime, we're paying sign-on bonuses, we're paying for registry and traveling nurses and temporary nurses. And we're largely filling our vacancies by doing that, and we're seeing a significant increase in our wages and wage pressure. But to be perfectly honest, particularly in the current surge, it's being overwhelmed by or more than offset by these really strong revenues, higher volumes on our acuity. On the behavioral side, honestly, it doesn't matter what we're willing to pay. In many cases, we're just simply unable to fill the vacancies. And the example that I gave before, if a nurse who makes $70,000 or $80,000 a year under normal circumstances, is presented with an opportunity to make $10,000 a week, and she goes into the office of the hospital's CEO and explains that to him or to her, there's really no counter to that. We wish them the best and encourage them to come back to work when they're finished. But it's not like raising their salaries by 5% is going to really change anything. And so the challenge on the behavioral side, quite frankly, is not increased wages but it's simply an inability to fill some of those vacancies.

The slots, yes. A question here about free cash flow and how you think about the uses of free cash flow. Buyback, M&A, dividend increase, sort of what's -- philosophically, where is UHS right now in terms of thinking about uses for free cash flow?

Yes. So I think the variable that has always been most difficult to predict in this equation is those external opportunities. We generally know what our operating cash flows are. We generally have a decent idea of what our CapEx spend is at least for the next several years. So the plug number is, are there going to be a lot of external M&A opportunities? And you probably know as well as anybody, Jim, that over the last several years, those opportunities have been -- certainly, the material opportunities have been few and far between. And so as a consequence, I think, particularly postpandemic, we've just become a more aggressive returner of capital to our shareholders, mostly through share -- elevated levels of share repurchase. And I suspect that will continue. I think we feel like our stock price is relatively undervalued at the current time. We feel like we're relatively underlevered at the current time. And as a consequence, I think unless we're presented with some unexpected opportunities to really deploy capital for M&A, again, in a big measurable material way, I think we're likely to continue to be a more aggressive returner of capital to shareholders, mostly through share repurchase, although increasing dividend is certainly not out of the question as well.

Right. And you touched on M&A. Is it still the case that you think the focus is perhaps more on behavioral health versus acute care? Or are there other areas that you have contemplated? Are there some sectors?

Yes. So look, I think we often say that we're relatively agnostic about where we invest our next dollar of capital, certainly, at least in terms of acute versus behavioral. We evaluate opportunities in both segments all the time. And I think our point of view is we'll invest wherever we think we can earn a compelling return. I think the fact of the matter is on the acute side, there just have not been a ton of acute care facilities for sale. I think to some degree, distressed facilities have been, in many ways, aided by the pandemic in the sense of an infusion of government subsidies, whether that's Medicare-accelerated payments or CARES Act grant funds or whatever, but it has helped facilities sort of get through the -- any sort of current distress that they might be facing. And then I think there's been a predilection on the part of not-for-profit acute care hospitals when they decide that they want to do something, sell, partner, joint venture, to do that with another not-for-profit if that's a potential opportunity. So there just hasn't been a ton of opportunities on the acute side. On the behavioral side, there's just been a lot of, what I'll describe as financial dollars, meaning nonstrategic dollars, private equity, venture capital chasing behavioral assets, which they find very attractive and a growing business. And that creates sort of a challenge for us because we see some of these deals going off at multiples that are 14, 15, 16x EBITDA. And obviously, we're trading at 8 or 9x. That makes the monetary, sort of, economics difficult for us. So we are looking at other sort of, I'll call them, kind of extensions of the continuum, whether that's telehealth or outpatient or subacute, we're looking at all those other opportunities. But I think a lot of the same dynamics apply to those businesses as well.

Right. And sticking with the theme on behavioral health, you've done a fair amount of de novos over the last few years. So is that something that we should expect -- it's a question about expect to accelerate here over the next few years that the economics seem pretty attractive on those versus doing M&A? And do you have sort of a number in mind as you think about 2022 and '23 that we want to do ex number of de novos per year? That's the follow-up.

So a lot of those de novos are in the context of these joint ventures or partnerships with acute care hospitals. It's worth noting, I think most people know, but something like 50%, a little more than 50% of all the behavioral beds in the U.S. are operated by acute care hospitals and hospital systems. And I think what we find is that many of those hospitals and hospital systems, they acknowledge they don't do a very good job of operating and maximizing the value of those beds and those assets and are looking for joint venture partners who are more dedicated behavioral operators. We're certainly not the only ones out there who fit that bill, but we're the largest for sure, and I think have a long track record of doing this. So we're going to open in just a few days a de novo in Milwaukee, which is our first behavioral facility in Wisconsin. We've done a number of joint ventures with the Providence system in the Greater Seattle market, with the Baylor system in the Greater Dallas market. We've opened a recent one with a partner in Missouri, Southeast Missouri. So yes, I think those opportunities will continue. Now by their nature, they are relatively sort of bite-sized opportunities. They're a $30 million, $40 million investment. So I don't know that they're moving the capital needle a huge amount over the next several years. But I think cumulatively, they will become the single biggest growth opportunity in the behavioral division for the foreseeable future, because I think there is a significant pipeline. It takes a while to do these deals. These not-for-profit operators are kind of slow and deliberate in their decision-making. But the pipeline, I think, we think, is pretty fulsome and pretty robust. And I think -- we think it's a really good opportunity and a really good mutually beneficial one. I think we bring expertise, efficiency and quite frankly, and we're encouraged by the fact that the acute hospitals want to do this because their perspective on this is their emergency rooms are filled with behavioral patients, and they don't see them changing anytime soon. So they don't want to get out of the business. They want to be invested in the behavioral business, but they want somebody who knows what they're doing to really -- we can say know what they're doing, but who is really dedicated to behavioral care to run those businesses.

Right. And Steve, a follow-up question here from the audience, just in terms of thinking about, obviously, the crisis we have nationwide and opioid addiction, have you ever contemplated looking at getting into inpatient-outpatient sort of treatment for opioid addiction in a deeper manner?

Yes. So we have and have always had a significant portion of our beds dedicated to drug and alcohol addiction treatment. Not necessarily opioid per se, but certainly drug and alcohol more broadly. I think one of the challenges, and it's a public policy challenge, is that a lot of these opioid users are not necessarily well insured. They're either uninsured or they may be Medicaid patients. There certainly are some commercially insured opioid users, et cetera. But I think what we're going to see over the next several years is as more and more of these opioid cases are settled and more and more of these settlement dollars are made available broadly as part of the settlement, you're going to see more opioid treatment dollars flowing to hospitals and other providers of opioid treatment. And we're certainly well positioned to take advantage of that. So I think you'll certainly see more of that over the course of the next several years.

Right. You announced a few months ago an investment through Premier. I guess, Premier put together a group of hospital systems and Universal, to invest in a drug company, a company that provides a lot of injectables and other drugs. Can you just give us a bit more detail about that? And is this something that you think is the first of other things you might do, investments in other type of manufacturers?

Yes. I mean so in some ways, Jim, I think this is tied to your first question about what we've learned from the pandemic. So when the pandemic began, people will recall that one of the real significant obstacles out of the gate was interruptions in the supply chain, particularly as it relates to PPE. And one of the big challenges was that the lion's share of PPE in the U.S. was coming from China. Not only from China, but from Wuhan. And so not only was Wuhan the center of the virus sort of inception, but a lot of the Wuhan manufacturing capacity was closed, et cetera. And so I think a number of folks, including Premier, really set about trying to diversify the supply chain and through their members, including us, support more domestic manufacturing, et cetera. So we've invested in a couple of PPE manufacturers and drug manufacturers, et cetera, so that I think overall, the supply chain has become a lot more geographically diversified than it was at the beginning of the pandemic. And I think it's a win-win for the hospitals, it's a win-win for the GPOs like Premier and obviously I think it's a win-win for the domestic manufacturers as well. So that's, I think, another important way that the overall health care sort of dynamic landscape has changed, and I think for the better. I think the likelihood that we're going to get caught short with a supply chain disruption the way we did at the beginning of the pandemic is much more -- has been much diminished.

A question here from someone regarding leverage and your thoughts. You had mentioned earlier that you sort of thought you were under-levered. Would the company consider levering up to buy back additional shares, to deploy more cash given that you believe the stock is undervalued? What's your -- philosophically, your view on leverage and guardrails on leverage?

Yes. So look, I think that as most people know us and have noticed for some time, I think we're certainly going to always be more conservatively levered, probably than most of our peers. But having said that, we can take on quite a bit of leverage and still be more conservatively levered than others of our peers. So yes, I mean, it really gets back to this, the same idea that we talked about before, Jim, it's really a judgment about will there be a significant other external opportunities [ as we had ] for UHS for a long time. I think back on one of the last times when we really became an aggressive share acquirer was sort of in the mid-2000s -- yes, 2004, '05, '06. And one of the sort of accompanying, I think, conclusions that we reached when we decided to become real active share acquirer at the time was that there just weren't that many external opportunities, and there weren't going to be. I think we're sort of on the verge of making that kind of decision again in the current time frame. So I think, for a variety of reasons, including the willingness to take on more leverage, the view that there probably aren't a ton of external opportunities of really measurable size and reality, et cetera, will likely result in our being a more active acquirer of shares again over the course of the [ year ].

Great. Thank you. Steve, that's the questions we've received. I really want to thank you for participating in our conference. Once again, thank you.

Thanks, Jim. Good to see you.

Good to see you.