Amedisys Positioning to Become the 800-Pound Gorilla of Home Healthcare

Guest post by Tuscadog

Insights from my interviews with AMED management and updated EPS forecasts:

It’s baffling why analysts are surprised that the healthcare bill will reduce Medicare billing rates. It’s clearly documented in the Senate bill. Amedisys (AMED) has explained in several recent presentations how it is prepared for these changes and will react by aggressively accelerating the acquisition program and industry roll up (consolidation) to maybe 20 players from 12,000 currently. CEO Bourne has stressed that AMED has a robust acquisition pipeline. AMED was previously restricting acquisition negotiations to companies with less than $100 million sales until there was clarity on the Healthcare bill package, which impacts seller pricing expectations - this is now resolved.

Acquisitions have been highly accretive to AMED and the payback has always been less than 3 years.

AMED employs the ‘bank roll up model’ which exploits tremendous systems efficiency and cost reduction through application of accelerating scaled operating leverage. AMED is well financed to execute the plan with $260 million of operating cash flow and ample lines of credit.

Most of AMED’s customers are in their 80s and are covered by Medicare, so the extended coverage of the Senate bill has only a limited impact on potential AMED volumes. The newly insured (under 65) will be mainly seeking doctors, treatments, drugs, surgery and hospital care. Yes, some of the 35 million will gain home healthcare (HHC) following accidents, diabetes, heart attacks, cancer, surgery etc. I have not built any incremental volume impact into my financial projections, but I would argue that this additional covered population underpins the belief that AMED can sustain strong volume growth.

Pricing is a complex and political dynamic with many moving parts. Not every analyst understands the complex formulae details: considerations include market basket impact on inflation adjustment, productivity adjustments, case creep (and expiry in 2011), outlier premiums and caps, rebasing, CMS holdbacks etc.

Most of the analysts have about a 2% net price reduction assumption for 2011. But they have been slow to recognize that the 2010 pricing has a ‘one time’ bonus of 2.5% released by CMS out of the 5% funding holdback reserve and this went into the base rate for 2010. This 2.5% will be taken out of the base rate in 2011. So, the analysts are understating pricing for 2010 and overstating pricing for 2011 (but some are also understating volume growth, discussed later).

Management seem to think that the ‘sum of all the moving parts’ price reduction, per publicly available information, for 2011, including the above mentioned 2.5% reversal, will be between 3 and 4%.

Analysts are also low (by my calculation) by about 30 cents in their 2010 forecast in that they are not yet factoring in the 3% rural pricing add-on approved by Medicare and effective April 27th.

About 25% of AMED’s business is in rural areas, so the additional revenue and margin will be: 3% x [$1.75b x 25% of business] x 2/3year = 8749k / 28.3 m shares = 31 cents per share.

I’m therefore raising my own EPS forecast for 2010 from $5.80 to $5.90

2011 EPS forecast

Apart from the pricing issue, forecasting 2011 EPS is very much influenced by analyst growth assumptions, both organic and acquisition related. Several analysts have also not factored in the growing leverage impact on margin coming from additional sales.

For example, on March 25th Stifel Nicolaus downgraded the stock with a $5 forecast, while on March 23rd the First Analysis Securities analyst, Tony Perkins, confirmed his overweight rating and set an EPS target of $6.20 and price target of $72.

The Stifel forecast is ignoring the planned pace of organic growth and acquisitions while (5 star analyst) Tony Perkins of First Securities Inc. is using a more aggressive cumulative growth rate assumption for 2010 and 2011 (which is correct in my opinion based on the publicly presented organic and accelerated acquisition strategy presented by CEO Bourne).

The 16 analysts are forecasting an average 14.9% sales growth for 2010 but only 9.1% for 2011.

This is the crux of your investment decision on AMED. You have to make your own judgments as to what growth rate assumption you use to offset the one time Medicare price adjustment in 2011. My investment bet is with management, since they’ve grown the company an average 25% during the past 5 years and AMED is destined to become a multi-billion-dollar company, dominating this industry.

• If I use the 9.1% growth assumption, positive EBITDA margin impact of leverage, negative pricing using worst case 4% down, I get a 2011 EPS of $5.07
• If I continue the 2010 15% growth assumption into 2011, I get a 2011 EPS of $5.39
• If I use a 20% growth assumption, I get $5.62
• If I use a 25% growth assumption (acquisition driven), I get $5.92
• (If the 4% price reduction comes out at 3%, then this would add about another 43 cents to these EPS forecasts.)

Tony Perkins has spent quite a bit of time visiting management, so he is more bullish on what acquisitions can be done in 2010 and 2011, hence his $6.20 forecast.

So, I expect that analysts will start adjusting their 2011 forecasts according to their own growth assumptions. I believe management feel analysts are underestimating their ability to now rapidly integrate and leverage acquisitions.

There is likely to be a hiatus in material Medicare pricing changes after the 2011 adjustments I’ve outlined, since the industry savings targets have been baked into the Senate Bill, to be enacted beginning 2014. So, EPS growth is likely to accelerate from 2011 until 2014 when there will be another slowdown.

Use your own spreadsheets, but mine assume that AMED’s EBITDA margin of 18% in 2010 will fall to 10% sometime within the 2014 to 2018 timeframe. AMED will, through acquisitions and organic growth, become a $5 billion company by the end of 2016 and this will produce an EPS of about $9 or more, i.e. huge volume growth producing tremendous leverage benefits, overcoming pricing erosion.

The industry pricing changes will devastate most small players and accelerate massive industry consolidation, leaving AMED as the 800-pound gorilla. You can do the math yourself, but clearly, given the long time frame for phasing in the pricing changes, the volume growth impact at AMED will far outstrip the margin erosion, ensuring healthy EPS growth from 2011 forward.

An added bonus could be erosion of the political will to cut costs to the planned degree and risk withdrawal of service to voters. Politicians love to ‘kick the can down the road’.

Other points that management have made:

AMED is pushing hard to grow the Hospice division, which is a much cheaper alternative to acute care hospitals, through acquisition. This division is now reaching efficiency and cost leveraging scale. Hospice is very synergistic with HHC, has the same referral sources, same 18% margins, but even better is unlikely to experience any push back by Medicare on hospice pricing as Hospice deals with ‘end of life’ situations, making withdrawal of service difficult.

AMED is increasing emphasis on ‘chronic care management' now. This opens up the opportunity for lifetime HHC potential (rather than episodic) and a focus on prevention of expensive hospitalization, which is attractive to both Medicare and insurers. This area promises major revenue growth for AMED. (12% of Medicare recipients incur 70% of the costs.)

The 3.5% per year rebasing planned in the Senate bill starting 2014 is a maximum, not an obligatory price reduction. The industry has 4 years to lobby its case for increased investment in HHC and preventative HHC vs. expensive hospitals.

A key point from March 10th Raymond James HHC conference:

The AMED CFO again emphasized the unusual growth potential of AMED. Branch start ups cost $300 to $500k and the investment is FULLY paid back in 18 months. After 2 years these new branches produce over $2 million in Revenue with a 30% contribution margin, i.e. $600k each. They opened 41 in 2009 and plan 50 in 2010, so about $30 million incremental EBIT from EACH YEAR’s new branch openings (which is additional to the organic growth of the existing 500 branches). Not a bad annual boost on a $260mm EBITDA base. (What a cash machine!)

Acquisition payback is a similar story, with less than 3-year cash payback (study the track record on earnings accretion). And, now AMED has staffed with a new CDO who is an expert on rapid acquisition integration with a proven track record - since AMED plans to 'roll up the industry'.

Caveat Emptor:

I’m an amateur investor, so do your own detailed research and make your own investment decisions. Never assume that analysts or anyone else is infallible. Projections are only as good as your (or my) assumptions. Use spreadsheets with different assumptions to test your assumption sensitivities. There is never a right or wrong answer, just different judgments

Disclosure: Author is long AMED