The company has evolved since its incorporation in 1970 through numerous acquisitions and divestments of diversified businesses. The most significant recent transaction involved the acquisition of the remaining 63% of common stock in previously privately held Vitas, which was not already owned by Chemed, completed on February 24, 2004, and the more recent disposal of the company's Service America subsidiary on December 29, 2004. The Service America subsidiary, located throughout Florida and in Phoenix, Arizona, was divested through an asset sale to employees of Service America.
Vitas Healthcare Corp.
Vitas Healthcare Corporation, based in Miami, Florida, is the nation's largest provider of hospice services with about a 7% share of the U.S. hospice market. Vitas commenced operations in 1978 and incorporated in 1983 as a for-profit organization. Vitas Healthcare currently provides services to almost 9,000 patients from 39 hospice programs in 11 states. These areas include: California, Connecticut, Delaware, Florida, Georgia, Illinois, New Jersey, Ohio, Pennsylvania, Texas and Wisconsin. Over half of Vitas patients receive care in their homes. Approximately 40% of patients receive care in skilled nursing and assisted living facilities.
The organization classifies its services based on location and type of care provided. The major classifications are: Home Care, Continuous Care, and Inpatient Care. Home Care refers to routine care provided to patients and their families residing at home or in a nursing facility, where the provider is paid the routine home care rate for each day per patient. Continuous care is the care provided to patients while they are at home during periods of crisis involving intensive monitoring and care. Inpatient care refers to short-term care provided in a participating hospice inpatient unit, hospital, or skilled nursing facility.
All Vitas operations, including clinical operations, billing and collections, accounts payable and claims processing, financial reporting, human resources, and compliances are supported by the company's proprietary information systems. The capital required to establish a single hospice facility is currently estimated at between $300,000 and $500,000. As a result, competition from non-profit providers, which constitute more than 72% of all hospices, is significant (albeit highly fragmented). A large number of hospice programs are owned by, or are part of, a larger healthcare delivery system, typically not-for-profit hospitals.
In addition to not-for-profit service providers, the industry is also characterized by a high number of small regional operators. However, nine of the top 10 providers, as measured by average daily census [ADC], are for profit. Average daily census refers to the total number of patients, regardless of the level of service. The major publicly traded hospice industry players, which include Vitas, Odyssey, VistaCare, and Manor Care, collectively only account for approximately 15% of the market. While the relatively low absolute capital requirements represent a low barrier to entry, the regulatory complexity associated with establishing a Medicare-licensed hospice location remains a significant barrier. In addition, hospice referral sources are largely dependent on relationships and reputations established over time through the provision of high-quality care and service.
On April 7, 2005, CHE announced that the Office of Inspector General [OIG] for the Department of Health and Human Services had served VITAS with civil subpoenas relating to VITAS' alleged failure to appropriately bill Medicare and Medicaid for hospice services. As part of this investigation, the OIG selected medical records for 320 past and current patients from VITAS' three largest programs for review. It also sought policies and procedures from 1998 to present covering admissions, certifications, recertifications, and discharges. The investigation is on-going and the OIG has not given indication regarding the results of their investigation to date.
Roto-Rooter, Inc. was founded in Des Moines, Iowa, in 1935 by Samuel Blanc, and is currently the largest provider of plumbing and drain cleaning services in North America. Roto-Rooter operates through more than 100 company-owned branches, independent contractors, and 500 franchisees. Either directly or indirectly via franchising, the total Roto-Rooter system is available to more than 90% of the U.S. population and approximately 40% of the Canadian population. Roto-Rooter also has licensed master franchisees in China, including Hong Kong, Indonesia, Japan, Mexico, the Philippines, and the United Kingdom.
In 1980, the Blanc family sold Roto-Rooter to Cincinnati-based Chemed Corporation and subsequently moved its corporate headquarters to Cincinnati. In 1986, Roto-Rooter was spun off as a public company, with Chemed retaining majority ownership. In August 1996, Roto-Rooter again became a wholly owned subsidiary when Chemed bought back all outstanding shares. The U.S. residential/light commercial plumbing repair/replace market is valued at nearly $8 billion, comprising more than 50,000 small regional plumbing companies. The competitive landscape for the drain and plumbing services industry is intense at a local level. Points of differentiation amongst participants include brand/name recognition, speed and quality of customer service, service guarantees, and pricing.
Our outlook for the medical care industry is positive. This industry has benefited in the last few years from favorable demographic trends and expanded Medicare reimbursements. There have been several notable disasters in this industry recently (ironically, due to issues with Medicare reimbursements). However, a favorable pricing environment, with tiered benefit plans and double-digit premium increases, coupled with stable inflation, should result in estimated earnings growth of 15% to 20% for the industry over the medium term. Medical care organizations will benefit from continued volume growth, innovative plans designed to moderate cost increases (along with higher consumer co-payments), better claims handling (leading to improved reimbursements from insurers), and expanded Medicare coverage and reimbursements.
Competition among providers may put downward pressure on margins, but an aggressive focus on internal cost reductions will benefit the well-run managed care organizations. The hospice care market is valued at $4.5B, according to the most recent Medicare spending data (2002). More patients and families are choosing hospice care for end-of-life illnesses each year, as the principles of palliative care become increasingly more recognized and adopted. Nonetheless, the industry remains highly fragmented with the top four hospice companies (VistaCare, Vitas, Odyssey, and Manor Care) collectively representing approximately 15% of the market. Furthermore, under Medicare, the hospice sector has received annual inflationary increases, while many other healthcare service sectors have had flat or downward trends
Notwithstanding regulatory hurdles, the financial barriers to entry to the hospice industry are relatively low. As a result, the hospice care industry is competitive albeit highly fragmented with over 3,000 service providers nationally. Based on industry data, more than half of existing hospice programs are local, not-for-profit programs. Most hospice programs are small and community based. Chemed Corporation competes with other multi-program hospice companies, including Odyssey Healthcare, Inc., SouthernCare Hospice, Inc., and VistaCare. In addition, the company competes with a number of hospitals, nursing homes, home health agencies, and other health care providers that offer home care to patients who are terminally ill, or market palliative care and hospice-like programs. In addition, various healthcare companies have diversified into the hospice market, including Beverly Enterprises, Inc. and Manor Care, Inc. Vitas was founded in 1976 and soon after participated in a federal government demonstration project of 26 hospices that developed model clinical protocols and procedures for hospice programs across the U.S.
As a pioneer in the industry, the company has well-established relationships with referral sources in a number of key states including Florida (where it has approximately 10% of the market), and California. Furthermore, the company s service offering spans all segments of hospice care and end-of-life disease categories, which we believe is a key point of differentiation. Vitas Healthcare was also, until recently, the only for-profit hospice provider in the state of Florida with a Certificate of Need accreditation. The Certificate of Need [CON] program was introduced in 1980 and is a regulatory process that requires certain healthcare providers, such as hospices, to obtain state approval before offering new expanded services, or making major capital expenditures. The CON process is intended to ensure that 1) proposed new services are needed, and 2) the existing organization is meeting the needs of the community it serves
On February 20, 2007, CHE announced 4Q06 financial results. The company reported net income of $17.6M, or normalized EPS of $0.73 (reported EPS of $0.67), compared with $4.2M or EPS of $0.16 in 4Q05. The reported EPS included: earnings loss from the discontinued program in Phoenix, AZ of approximately $0.06 per share: and a slightly lower tax rate of approximately $0.04 per share. Total revenues for 4Q06 was $271.9M, up 9.5% y/y, compared with $248.2M in 4Q05. EBITDA in 4Q06 was $38.2M, up 3.6% y/y, compared with $37.3M.
The hospice segment [VITAS] generated net revenue of $186M in 4Q06 up 11.8% y/y. Net income from continuing operations for 4Q06 was $15.1M. Medicare Cap accruals negatively impacted revenue by $0.7M and reduced net income by $0.4M. ADC increased 9.4% to 11,174 and admissions increased 7.4% to 13,291. Gross margins in 4Q06, before the impact of Medicare Cap, were 22.8% compared to 22.9% in 4Q05.
The plumbing and drain cleaning business (Roto-Rooter) generated sales of $86M for 4Q06, up 8.2% y/y, compared with $79Min 4Q05. Net income for 4Q06 was $9.7M, up 32.3% y/y, compared with 4Q05. Adjusted EBITDA in 4Q06 was $17.2M, up 18.4% y/y, and resulted in an adjusted EBITDA margin of 20.1%, an increase of 173 basis points compared with 4Q05.
Management FY07 guidance pegged revenue growth for VITAS, prior to Medicare Cap, of 11% to 13%, increased admissions of 5% to 7%, increased ADC of 8% to 10% and adjusted EBITDA margins, prior to Medicare Cap, of 13% to 14%. The guidance assumes a Medicare price increase that will average 3.8% in the first three quarters of 2007 and that hospice receives a full Medicare basket price increase of 3.5% in 4Q07. Roto-Rooter is expected to generate a 7% to 8% increase in revenue in 2007, job count growth between 0.5% and 1.0% and adjusted EBITDA margins of approximately 17%.
We have valued CHE on a forward price/earnings (P/E) basis, as well as a comparison to similar firms in the hospice sector. Our price target of $53 is derived using a multiple of 22 times (x) FY07 EPS of $2.40.
Adverse changes in the rates or methods governing the Medicare and Medicaid payments could depress Vitas net patient revenues. If Vitas is unable to attract qualified nurses and other healthcare professionals at reasonable costs, earnings growth could be less than projected. Roto-Rooter branded systems could be superseded by competitors technologies.
INSIDER TRADING AND OWNERSHIP
Insiders control approximately 6% of the total shares outstanding, with Institutional holders at approximately 83 %. The top four institutional holders are: BAMCO (6.1%); Mellon Financial Corporation (5.1%); Barclays Global Investors UK Holdings Ltd (4.9%); and Iridian Asset Management LP (4.3%). Over the past six months, insider trading in the company s common stock has been negligible.
PROJECTED INCOME STATEMENT & BALANCE SHEET
CHE, through its two primary subsidiaries of Vitas and Roto-Rooter, is a major player in both the hospice and plumbing industries, respectively. The company reported better than expected net income of $17.6M, or normalized EPS of $0.73 (reported EPS of $0.67), compared with $4.2M or EPS of $0.16 in 4Q05. The reported EPS included: earnings loss from the discontinued program in Phoenix, AZ of approximately $0.06 per share. The result was characterized by a solid increase in VITAS related earnings primarily driven by admissions growth of 7.4% y/y. We retain our Buy recommendation at current levels.
CHE 1-yr chart: