5 Cheap Home Care Companies Beaten Up by the Market

 |  Includes: AFAM, AMED, ANTM, LHCG, SPY, WCG
by: Hedgephone

"Wall Street traders now make more than brain surgeons," a CNBC pundit recently announced, as "Recruiters estimate that an oil trader on Wall Street with ten years in the business is likely to earn at least $1 million this year, while a neurosurgeon with similar tenure on the job makes less than $600,000. Likewise, bankers involved with mergers will take home about $2 million after a decade on the job this year, more than ten times what a cancer researcher earns at the same stage in their career," according to NY Magazine.

What many people misunderstand about investing in financial markets, is that most investors find taking money off the table after a successful investment impossible. Many long term investors view selling a stock at a profit as speculative when they probably should view this as tangible earned income when the story or discount to valuation has changed.

Making money in the stock and commodity markets is about as difficult as brain surgery, because 99% of investors lose money trading stocks and commodities. The good investors and traders have to work 18 hours per day to make a living. So while the gross pay is higher as a trader, the hours on the job are also higher (some in finance work 120 hours per week for 100K per year, or around minimum wage!) and the job security is non-existent -- you truly are only as good as your last "trade" or investment. Another reason that surgeon pay is lower than financial market pay, is a free market ideology that does not value service to society at large as an asset as much as it does cutting costs due to fiscal imbalances and limitations due to our incredible national debt. The fact of the matter is, the government is broke but they want to completely control the home health and medical industries with the last of their deficit spending measures. While idealistically sound, the impact on the sectors and industries that are being affected are dire and regrettable. Most government involvement in the past centered around lowering prices (competitive bidding in healthcare weeds out all of the mom and pop players and gives that market right to the big boys).

So in essence, the more the government becomes involved in health care and middle management of private industry through moves like competitive bidding and Medicare cuts, the worse the pay will be for doctors and surgeons in the industry, which is a shame. Doctors should make more than traders!

How does all of this relate to the stocks on this list? Investors will be forced to learn the ins and outs of the 160 panels, boards, and departments created by Obama-care or else end up broke like the other 99% of people in the market. While I like the idea of nationwide healthcare, I know from experience that Medicare benefits the largest firms in the market and hurts the private practice or mom and pop home care provider. In essence, the stocks I have researched here are values, but the uncertainty around new healthcare legislation that is now tainting valuations in the sector may not go away any time soon.

Bottom line: The following 5 healthcare stocks are cheap, but likely for a good reason -- the U.S. Government has created substantial uncertainty in earnings sustainability in the home healthcare and health insurance industries. While I view this uncertainty as a buying opportunity, selling calls against your stocks in these names creates an added margin of safety. Because a covered call strategy in these stocks can yield returns nearing 30% per annum, I think buying and holding these names no matter what is too risky a bet here. (AMED Feb. $32 calls can be sold for $1.10 or so yielding an over 3% monthly return -- if 3% a month is not good enough for you, ask yourself if you're being greedy!)

  1. LHCG Group (NASDAQ:LHCG) provides post acute healthcare to Medicare beneficiaries. Competitive Bidding and Medicare have completely reshaped home care time and time again and LHCG is likely undervalued relative to the S&P due to this uncertainty. LHCG is in the hospice, home nursing, and long term care markets which are not as valuable as home oxygen but should still be worth a 1X sales multiple. When I worked in M&A the typical valuation for this type of home care company was in the range of 1-1.5X sales, if you had mostly Medicare business and a lot lower at around .5X sales (if anything) for home care providers who provide non-Medicare reimbursed services. (I'm a former broker/ M&A advisor in 02 and home care and can attest to how hard Medicare is on the small provider.) LHCG trades at just .87X sales, 10X earnings, an EV/EBITDA multiple of 5, and has a quarter over quarter earnings growth rate of 35%. LHCG is a Magicformula.com stock and appears to be undervalued from a private M&A market perspective. Basically, if you buy LHCG here you should make some decent money over time with the appreciation of the business's value and can earn a better risk adjusted return by selling front month near the money covered calls on the stock. LHCG's return on equity of 21% is likely inflated from a 1.6X debt/equity ratio, but the company is still a bargain even though it has taken on a little more debt than we normally like to see. The stock has a Beta of .84 which should mean absolutely nothing to you if you are a long term value/growth investor, but means it's a bit less volatile than the market -- traders should sell some calls against the name for added income and reduced volatility.
  2. Amedisys (NASDAQ:AMED) is trading at just 6.4X last years earnings of over $4 a share which is up from $1.7 a share earned in 2006. The canary in the coal mine for AMED is Obamacare and the uncertainty surrounding Medicare reimbursement situation. 2010 estimates are for $4.20-$4.35 full year EPS and 4% revenue growth. At a price of $31 AMED appears to be 35% undervalued from a private market M&A multiple of 10X net income. AMED boasts a .69 PEG ratio, which is very cheap.
  3. Wellcare (NYSE:WCG) is an old holding of Bruce Berkowitz which has recently fallen off a cliff due to a 128MM quarterly loss this past summer. If the company can turn itself around, WCG may be able to earn 250MM of free cash flow again as it did in both 2008 and 2007. While much riskier than AMED, Gilead Sciences (GILD), and LHCG, this potential turnaround could yield big results for gutsier investors.
  4. Almost Family (NASDAQ:AFAM) is a bit more expensive than its home care competition, trading at 11X earnings. However, AFAM boasts much better historical sales and earnings growth than its peers. AFAM has grown earnings from $7.6MM in 2007 to over $30MM last year -- a remarkable 400% increase. AFAM carries a .7X PEG ratio, making it very cheap if those earnings can continue to grow in the future. In addition, AFAM trades at just 5X EV/EBITDA with a 19% ROE and a 9.4% net margin, which means that my old boss in home care M&A would say that it's "not a roach" and that it wasn't my usual "wood" that I brought into his office. (companies that had under 1MM in sales, for example, were usually impossible to sell to the majors). With a 1X sales multiple, AFAM would be in the bottom of the 1-1.5X sales range we used to value home care companies.
  5. WellPoint (WLP) is trading for 5X trailing 12 month earnings with a 2.6X EV/EBITDA multiple, making it a good candidate for investment and potentially undervalued. Full year 2011 results should see WCG trading at a 9.4X forward PE ratio, according to analysts, so hopefully growth will pick up for WCG in the future. Wellpoint is trading at a 1 PEG ratio, but remember in a centrally planned economy PE ratios and future growth projections are much less reliable. So selling covered calls makes plenty of sense to me.

So there you have it; five cheap healthcare companies that are trading at valuation troughs only shared with reverse merger Chinese companies. The big difference is that these stocks above do not have Canadian CPAs no one has heard of auditing their SEC filed books (we hope). So remember, the free markets drive innovation in health care, but Medicare is the 5 trillion pound gorilla in the room, so make sure you don't go "all in" on the home care companies. After the last round of cuts and competitive bidding, Lincare and Apria literally either bought you out or you went under due to competitive bidding (if you can't provide homecare at a lower price than Lincare, you don't get the Medicare bid). Hopefully this time it's different, but make sure to actively study the effects of new legislation on these companies so that you end up with the rich 1% of traders and not the 99% who wish they went to Med School instead of dabbling in the market.

Chart forAmedisys Inc. (<a href='http://seekingalpha.com/symbol/AMED' title='AMEDISYS Inc'>AMED</a>)

Chart forAmedisys Inc. (<a href='http://seekingalpha.com/symbol/AMED' title='AMEDISYS Inc'>AMED</a>)

As you can see, these companies along with the S&P 500 have gone virtually nowhere over the past five years, which may mean the negative headwinds and uncertainty are already priced into these stocks or that they are cheap for a reason. With the baby boomers hitting 60 and 70, the market is going to grow at a rapid pace -- the real question here is whether the smaller providers will be squeezed out of the marketplace.

Disclosure: I am long LHCG, AFAM, AMED.