I got interested in home healthcare stocks lately after the whole sector's recent selloff due to changes in Medicare/Medicaid payments, as well as the SEC lawsuits of fraudulent actions by the providers. Following is a report on my valuation of Amedisys (AMED) stock, the reason I bought it, the reason I sold it and the lessons I learnt.
- It is the largest player in home health care, which is a very fragmented industry.
- The home health care industry is set to grow 50% by 2020 because of aging demographics. Home health care makes a lot of sense when you compare it to the cost of treatment within hospitals.
- To top it off, most elderly people prefer in-home health care over a hospital stay.
- Amedisys has grown significantly by acquiring offices and reducing their costs by centralizing management cost. Hence, it has an economy of scale advantage. This seems to help it obtain industry leading operating margins and free cash flow. Acquisition and consolidation has been going on in this sector since 2000 because an acquiring company can make existing offices more profitable by centralizing fixed costs.
- Free cash flow for 2009 was 125M
- Expected free cash flow for 2010 is 130M
- With a market cap of 700M and debt of 200M, the enterprise value/FCF = 7 for 2010, which looks like an awesome buy for a growth company.
- The CEO founded the company in early 90s and owns 1% of the stock. His salary, even though it is high, is not ridiculous. The directors have been with the company for over 10 years.
- As of 2Q 2010, Amedisys has 116 M in cash and 162LT + 40ST debt ,making the lowest the stock can get zero. The majority of its balance sheet is comprised of goodwill, which shows that when it acquires a business it pays a lot more than the assets of the company. Are those assets worth the premium? At first glance it seems it is worth it since they have contributed to an increase in free cash flow, and Amedisys has reduced outstanding debt quickly as post acquisition.
- In April, the WSJ (see here) basically they accused home health providers of swindling Medicare into paying more by doing more home visits than necessary. The company replied by issuing this shareholder letter.
- It was cheap, even though the downside was zero.
- The accusations of fraud seemed misguided by looking at both Amedisys and WSJ data.
- It operates in a growing industry and has a scale advantage. Any reduction in Medicare reimbursements would negatively impact the smaller players first and hence provide even more opportunity of growth for big players like Amedisys.
- After buying the stock I heard the 1Q and 2Q conference calls. It seems that management has suddenly made significant changes to their operating model since the WSJ article.They are decentralizing their operations while touting this centralization as the reason they were able to have high operating margins. I also read a theory that the centralized version could have allowed them to do Medicare fraud and that they are moving towards the industry standard decentralized model after the WSJ article to hide their existing issues.
- Management did not seem candid. They kept talking about cutting costs by closing offices and bringing the salaried employees to pay per visit reimbursement. But when asked how many offices they plan to close, how much benefit that might have or how many employees are on salaried basis, they declined to disclose. In the company's Q1 conference call, when they announced the closure of unprofitable offices, they said they will give more details in Q2, which they did not. So something is fishy.
- The biggest reason for selling the stock was when I found out that the Medicare reimbursements are going to fall by 5% in 2011 and 5% more in 2012. That will cut their EBIT margin from its current 15% to 5% and reduce the free cash flow by 70%. I should have known this before I purchased the stock.
- Clinician recertification to Amedisys (a process of extending the treatment of a patient, and as a result allowing Amedisys to get paid again for the same patient) fell off a cliff in the month of June and has remained that way. This is very suspicious since that when they said they started decentralizing the operation. Also, it's possible that the doctors are referring to some other agency because the WSJ article highlighted Amedisys. Management was asked multiple times during both conference calls regarding about the sudden drop, and they said that they have no idea what happened. This is definitely very very suspicious. If management does not know what's going on, then who will?
- Lastly, I found a website in which thousands of Amedisys employees reviewed the company. 99% of the people had bad things to say, especially the employees who became part of AMED after acquisition. The work culture was very very stressful and filled with bureaucracy. All the employees said that they would change jobs in an instant if given an option.
- Buy a stock with a worst case downside much higher than 0.
- Do your homework before the purchase.
- Stress the qualitative factors much more than quantitative ones since the former is hardest to evaluate.
- Home health care industry has two segments - one that helps old people do regular chores, etc., and another that takes care of people with acute diseases. The latter segment is called Hospice. In the health care overhaul the reimbursement for this segment has not been reduced. Hence, all of a sudden this seems like the well established segment in the HHA industry. The recent acquisition of Odyssey Healthcare by Gentiva, at a huge premium price, proves this. Amedisys did 95% of the first segment but very little of Hospice.
- Basically, I should stay away from a business whose operating profits could be significantly impacted by government actions.
Disclosure: No positions