Tenet Healthcare's Q2: Margins Shrink as Labor Costs Hold the Line

Tenet Healthcare's second quarter came in below the operating-income target the company set three months ago, with higher labor costs and a shift in payer mix eating into margins at its acute-care hospitals.

The Dallas-based hospital operator reported adjusted EBITDA of $1.15 billion for the three months through June, up from $977 million a year earlier but short of the $1.17 billion midpoint of the guidance range it issued in April. Revenue hit $5.4 billion, roughly in line with the $5.3 billion to $5.5 billion forecast.

The miss was concentrated in the hospital segment. Adjusted EBITDA margin there came in at 18.4%, down from 19.1% in the first quarter and below the 19%-plus level the company had flagged as sustainable. Labor costs contributed: contract labor expense, while down from peak pandemic levels, ran about $40 million above what Tenet had budgeted for the quarter, CFO Daniel Cancelmi told analysts on the earnings call.

Payer mix also turned slightly negative. The share of patients covered by government insurance programs ticked up versus the prior quarter, while the share of commercially insured patients slipped. Since commercial rates run roughly double what Medicare pays for comparable services, the mix shift added pressure on margins at the individual hospital level.

Tenet's ambulatory segment – its network of outpatient surgery centers and imaging facilities – performed better. Adjusted EBITDA there rose 12% year over year to $327 million, with same-store revenue growth of 7.3%. The company has been shifting capital toward that side of the business, and CEO Saum Sutaria said the unit is on track to hit its full-year target.

The company tightened its full-year adjusted EBITDA guidance to a range of $4.59 billion to $4.79 billion, from $4.55 billion to $4.85 billion previously. The new midpoint of $4.69 billion implies second-half EBITDA of roughly $2.37 billion, up from $2.33 billion in the first half.

Tenet's Alpha Score sits at 36 out of 100, a Mixed rating driven by a weak earnings-momentum subscore that reflects the Q2 miss. The stock has fallen about 11% since the print.

Sutaria said the company expects labor costs to moderate in the back half of the year as it pushes through a new round of contract renegotiations at 10 of its larger hospitals. The renegotiations, which began in late June, cover about 30% of the company's contract labor spend. If those talks produce the targeted savings, hospital segment margins should return to the 19% range by the fourth quarter, Cancelmi said.

The ambulatory business is on track to add 12 to 15 new surgery centers this year, Sutaria said, with the first two opening in the third quarter. Tenet is also expanding its imaging network, with plans to add eight new fixed-site centers by year-end.

Free cash flow for the quarter came in at $312 million, down from $348 million a year earlier, partly because of higher capital spending tied to the ambulatory buildout. The company maintained its full-year free cash flow guidance of $1.3 billion to $1.5 billion.