LHC Group: Senate Investigation Offers Buy Opportunity

by: Strubel Investment Management

LHC Group (NASDAQ:LHCG) is a medical service provider that supplies home health, hospice, private duty and long-term acute care. The company’s primary business is providing home nursing care to geriatric patients. The company also operates several hospitals, hospices, and other medical facilities. Medicare reimbursements account for over 80% of the company’s revenue.

With an aging U.S. population and expanded healthcare coverage, the company operates in an attractive growing market yet only trades at 13-14 times earnings. Why is that? There are likely two interrelated reasons.

First, during the past two years Congress has kept the Medicare reimbursement rates for home care services flat. Prior to that, Congress had been increasing the reimbursement rate roughly in line with inflation. Also MedPAC, a political action committee, has recommended that Medicare cut its reimbursement rates.

The MedPAC issue does not seem worrisome as MedPAC has basically always recommended cuts or no increases to reimbursement rates due largely to fraud in the home healthcare field. It is helpful not to focus on reimbursement rate trends as increases are random. From 2005 to 2007, rates were increased. If you were thinking about making an investment at the end of 2007, you would have looked at the trend and assumed that Congress would continue to up the rates. But you would have experienced them as flat in 2008.

Based on that, I would not read too much into why Congress chose to leave rates flat for 2008 and 2009. They seem just as likely to raise rates as to leave them flat in any given year. With flat rates or even cuts, LHC Group and all of the larger home healthcare providers will remain profitable as they benefit from economies of scale that smaller providers do not have.

Second, there is currently an investigation by the Senate Finance Committee into the four largest home nursing care providers: Amedisys (NASDAQ:AMED), Almost Family (NASDAQ:AFAM), Gentiva (NASDAQ:GTIV), and LHC Group. The investigation focuses on billing practices; specifically, Medicare reimburses providers with extra payments after six, fourteen, and twenty therapy visits. The committee is investigating whether the providers intentionally provided unneeded services to reach the visit thresholds and trigger the bonus payments. While questions have swirled over Amedisys’s billing practices for years, LHCG has not seen any scrutiny until now.

Based on documentation released by LHCG so far, there does not seem to be any cause for concern. According to LHCG, their therapy visits did not change after the Medicare payment structure changed. They report,

The average number of therapy visits received by our top 20 patient diagnoses that required therapy in 2007, as compared to those same patient diagnoses in 2008, was consistent despite the change in therapy thresholds from 2007 to 2008. In fact, in none of those top 20 diagnoses did the average visits increase to a level that would result in our meeting or exceeding a higher therapy threshold.

But we don’t have access to all of the documentation to make any firm conclusions, so let’s use a technique promoted by the late Phillip Fisher. His term for the technique was “scuttlebutt,” meaning “what is the word on the street”. What do employees, customers, suppliers, etc., say about the company? Thankfully with the advent of the internet our job is easier.

A quick search of job and nursing message boards reveals the following. The indeed.com message boards have almost 200 posts about Amedisys and a large number of those are by employees and former employees complaining about potentially fraudulent billing practices and how they are treated by the company. In contrast, the LHC Group forum on indeed.com has one post (the user was having trouble accessing an online application to apply for a job).

On the allnurses.com message board there are 4 discussion threads for LHC Group, most dealing with questions regarding employee pay and how to get a job there. Contrast that with 59 threads for Amedisys, including many threads filled with complaints regarding nurses who were asked to change the billing codes for patients in order to justify higher rates/more visits.

While one would expect Amedisys, which has 16,000 employees to LHCG’s 6,500 employees, to have more people discussing working there and thus more people complaining, I was surprised by the scale of the disparity. For reference, Gentiva had 114 threads at allnurses.com and about 60 replies on indeed.com. Almost Family had 14 threads on allnurses.com and 2 replies on indeed.com. Gentiva and Almost Family have 17,000 and 4,800 employees, respectively.

The only discussions with Gentiva and Almost Family seemed to be the usual complaints from unhappy former employees regarding their own pay and “bad” managers. Of course, this does not mean LHCG did not commit in any fraud. With 6,500 employees it is a given that somewhere someone engaged in some bad behavior.

The question is whether it is systemic throughout the company or whether there are a few random cases of middle managers or supervisors doing something they shouldn’t have done. Judging by the lack of complaints, specifically regarding how billing is done, I believe it is more likely that there is no systemic fraud at LHC Group.

How much is LHC Group worth? Over the past five years (excluding the crash of 2008) it traded in a range of 15 to 24 times earnings. With a growing market and attractive margins, I think a conservative fair value would be slightly above the long-term average of the S&P 500, perhaps in the range of 16 to 18. Using trailing twelve months earnings of $2.45, that would give a fair value of around $42 (17 x $2.45). A discounted cash flow model using very conservative assumptions of five years of 5% cash flow growth followed by long-term growth of 3.5% and using a 10% discount rate gives us $42 per share as well.

Despite all of the current controversy LHC Group looks like an attractive buy. Anyone buying now will likely have to endure some ups and downs, as I am sure there will be more bad news regarding competitor Amedisys.

But just like the financial crisis of 2008 allowed savvy investors to pick up great banks such as Wells Fargo (NYSE:WFC) and Hudson City (NASDAQ:HCBK) on the cheap, the Senate investigation has made shares of home healthcare providers cheap. Just as with the banks, invest in the cream of the crop and leave the rest for someone else.

Disclosure: Author holds a long position in LHCG

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