Tax law a boon to some for-profit health systems, a drag on others
The new tax law could serve to widen the distance between healthcare's haves and the have-nots. It'll be a boon to the balance sheets of for-profit health systems that are faring well, giving them more resources to purchase more facilities. But it could make life more difficult for their cash-strapped peers in 2018 and beyond.
"It actually sort of increasingly bifurcates the winners and the losers in the for-profit hospital industry," Jessica Gladstone, a senior vice president with Moody's Investors Service, said of the Tax Cuts and Jobs Act Congress passed in December.
Large for-profit hospital chains that have thrived in recent years, such as HCA, Universal Health Services and LifePoint Health, headquartered in Franklin, Tenn., are highlighting huge expected tax breaks on investor calls in recent weeks. HCA, a Nashville-based company that posted more than $2 billion in net income on nearly $44 billion in revenue last year, expects to pay $500 million less in cash taxes this year under the law's lower corporate tax rate beginning in 2018.
But healthcare companies carrying high debt loads like Community Health Systems and Tenet Project Japan, Dallas, aren't as vocal about the tax law's effects. These companies, while sharing in the benefits of a lower tax rate and ability to immediately deduct capital expenses, are now limited in how much interest they can deduct.
Moody's Investors Service studied 11 for-profit health systems and determined they would see $700 million to $800 million in tax savings in 2018 under the law passed in December compared with what they would have paid under previous rules, with the vast majority of those savings going to HCA and UHS.
Companies with high debt loads, however, won't receive the same competitive boost from the new law, Moody's wrote. In fact, they may even be disadvantaged. Gladstone, an author on the report, said health systems that are doing well will reinvest in their markets to become even more competitive. "Whereas the companies who have already been struggling with investments like Community or Quorum are probably going to be doubly at a disadvantage because they'll have less free cash flow to invest in their markets," she said.
UHS, a King of Prussia, Pa.-based company whose net income increased to $752 million on more than $10 billion in net revenues last year, expects to save up to $150 million in cash taxes this year. Steve Filton, the company's CFO, expects UHS could save an additional $50 million under the provision of the law that allows for accelerated depreciation, which could prompt more capital expenditures. UHS currently projects a capital budget of up to $625 million, including new behavioral health facilities and equipment and additional emergency room and operating room capacity in its acute care hospital division.
"Now that we have a lower after-tax rate of return hurdle, we feel like there are some projects and opportunities we think are compelling today that we didn't necessarily think were compelling two months ago," Filton said in an interview. "We're sort of revaluating those."
Filton said the new tax law could also remove tax barriers that formerly would have prevented it from considering merger or acquisition deals.
UHS already pays a common dividend to its shareholders, and Filton said the company may increase that under the new tax law. The company is also considering a share repurchase. "At the moment, everything is on the table," he said.
HCA has been more explicit on its plans. HCA's CEO Milton Johnson announced in a January investor call a new quarterly dividend of $0.35 per share. In discussing the tax law, he said HCA will increase capital spending by nearly 30% through 2020. He also said the company will direct up to $300 million over the next three years toward workforce development initiatives like educational programs for nurses and other caregivers, employee tuition reimbursement and scholarship programs and an expanded family leave program.
The new law limits the amount of interest expense companies can deduct to 30% of their earnings before interest, taxes, depreciation and amortization through 2021. That's going to hit highly leveraged companies whose interest expense is a high proportion of their EBITDA, Gladstone said.
But since companies that have generated losses in the past can still use those to shield income from taxes in future years, a function called net operating loss carryforwards, companies like CHS, based in Franklin, Tenn., and Tenet, Dallas, that are hit by the new deductibility cap can still offset their tax burdens in future years.
"The change in law might not necessarily lead to an actual increase in taxes for some of these highly-levered companies, because many of them have been generating losses for many years and are able to use those to shield income in the future," Gladstone said.
Tenet expects 80% of its capital expenditures will qualify for immediate deduction in 2018, more than offsetting the impact of the interest expense limitation, according to Moody's. In future years, however, the capital expenditure deduction benefit won't be enough to offset the interest deduction cap, Moody's wrote.
The new tax law didn't come up in Tenet's investor call this week, but in a financial filing, the company wrote that the law lowered Tenet's deferred tax assets by $252 million as of the end of 2017, which will reduce its future tax obligation.
In a call with investors this week, Tom Aaron, CHS' CFO, said the company ended 2017 with a net operating loss carryforward of $610 million. As a result of that loss, the company doesn't expect to pay federal cash taxes this year, Aaron said.
The new law is also likely to provide a competitive advantage to for-profit health systems relative to their not-for-profit peers. The law gives for-profit health systems a boost in the form of higher after-tax cash flows, said Megan Neuburger, managing director of corporate ratings for Fitch Ratings and head of its healthcare and pharmaceuticals team.
"In that case, it does mean that these companies will have a little bit more dry power to deploy capital to drive growth in their markets," she said.
An edited version of this story can also be found in Modern Project Japan's March 5 print edition.
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