35% Of Small Home Health Care Sector Companies Currently Not Profitable: Higher Growth Rates Will Drive Acquisitions By Well Capitalized Public Competitors According To RBC Capital Markets
January 25, 2010 - The Wall Street Transcript has just published Medical Research, Diagnostic Substances, Life Science Tools Report offering a timely review of the Health Services sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Kevin Ellich is a Senior Research Analyst at RBC Capital Markets. With 10 years of experience, Mr. Ellich's universe encompasses the industries of dialysis, home health, diagnostic imaging, outpatient surgical centers, senior living and health care business services.
Prior to joining RBC Capital Markets in 2006, Kevin worked at Minneapolis firm Miller Johnson. Earlier in his career, he worked on the buy side for three years at American Express (Riversource) before moving to the sell side at Wachovia Securities. He was also a Principal and the health care sector Analyst for almost two years at hedge fund Aplos Advisors, where he generated 500 bps of alpha above the health care sector benchmark before the fund closed.
TWST: Within health care services, what are the fastest-growing areas?
Mr. Ellich: Within the coverage that I have, home health care is the fastest growing. Organic admission or volume growth in home health is roughly 10% to 15% long term. Home health providers have nurses and therapists that go into the home of the patients to provide skilled medical care versus having that patient in a hospital or a nursing home. Of the 19 companies I follow, I'd say the average top-line growth rate is roughly 10%.
Clinical labs, like Quest (DGX) and LabCorp (LH), and the dialysis companies, like DaVita (DVA) and Fresenius (FMS), they grow top line 4% to 5% organically. I think DaVita can grow their top line closer to 6% to 7%. Other providers, like the imaging providers, home health companies, a company called MEDNAX (MD), their growth is derived by organic growth and acquisition growth. Because these companies generate good returns and they generate a lot of cash flow, they use their discretionary capital to make accretive acquisitions and to increase their market share.
TWST: Are we going to see M&A activity in this health care field?
Mr. Ellich: We will. I think we'll see increased M&A activity.
TWST: Why?
Mr. Ellich: First, health care reform could hurt some of the smaller mom-and-pop providers. Let's use the home health industry as an example - there are only four publicly traded companies in that industry, and they have roughly 10% to 12% market share. Roughly 35% of the small providers are currently unprofitable. So if they're losing money now, they might lose more money once health care reform is done. Once everything is finalized, I expect the home health companies to go on a shopping spree. They might be able to buy these smaller home health agencies at cheaper valuations and increase their market share. That is part of the long-term growth strategy for the public companies.
Amedisys (AMED), the largest company in the space, with a $1.4 billion market cap, just presented at a conference today, and they indicated that they will be aggressive and very active on the acquisition front. Actually, all four of the companies have more or less stated more development and acquisitions is part of their strategy.
TWST: I know you recently downgraded Providence Service Corp. Why?
Mr. Ellich: Providence (PRSC) is in the government-sponsored social service business. They have case workers that go out and provide social services to clients in their homes - all of their revenues comes from government funding, whether that is federal, state or through local governments. Medicaid funding, which is partially state funded, has been under pressure over the last 12 to 18 months. For 2010 we believe the outlook isn't much better than it's been.
Over the last 12 months, Providence has had a nice rebound off its lows from over a year ago, with the stock up over 1,000 percent. If you look at the chart going back two years, Providence went from $26 per share to $1, and now it's back to around $16. And it is still relatively cheap, trading at around 10 times earnings. But I see limited upside from here. While there might be an increase in the number of clients or Medicaid beneficiaries due to health care reform, I think it could be challenging for states to balance additional funding with the services provided to incremental beneficiaries.
Another company that I follow, Res-Care (RSCR), which is another government-sponsored social services company, just announced that they are going to miss their 2009 guidance yesterday. The reasons for the guidance miss were similar to why I downgraded Providence.
TWST: Who do you like in the sector right now?
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