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The Center for Medicare and Medicaid Service's (CMS) recently announced a Skilled Nursing Facility (SNF) Medicare rate reduction. With this announcement, nursing home shares have fallen from their lofty heights to year ago levels. The roller coaster ride for investors has been disconcerting and costly. Sadly, analysts did little to cushion the blow.

The expectation that high SNF Medicare rates would last was unreasonable and unfounded. Investors got a wake-up call on April 28 when CMS offered slim hope of a favorably outcome by proferring ambiguous guidance of either a 1.5% increase or an 11.3% decrease to the current rates. On the surface, this contradictory statement seemed an indication of dysfunction at CMS. It was also a reflection of the complicated rate making policies that had already committed CMS to its 2012 rate change. Regardless of CMS’ intention to provide visibility over 2012 rates, the agency has an obligation and the right to correct mistakes in its pricing model. The errors CMS was dealing with seemed to derive from its expectations of provider behavioral changes subsequent to the implementation of RUG IV in October 2010.

As I wrote in February in “Medicare Misses the Mark”, CMS had miscalibrated Medicare reimbursement rates implemented on October 1, 2010. While this contention was bolstered by the high Medicare rates public nursing home businesses were earning against a stated backdrop of “revenue neutral” CMS expectations, the subsequent notice on April 28th should have provided sufficient cause for investors to flee their positions. Then, on July 8th, the OIG announced concerns amid its own computation of overpayments amounting to 16%. Here was the smoking gun, yet somehow it was largely ignored.

Upon release of the new rates on July 29, senior care industry stocks collapsed (with Sun Healthcare Group (NASDAQ:SUNH), Five Star Quality Care (NYSE:FVE), Skilled Healthcare Group (NYSE:SKH), Kindred Healthcare (NYSE:KND) and The Ensign Group (NASDAQ:ENSG) all down over 33% in the past month). Eventually these losses hit the related REITs (with Senior Housing Properties Trust (NYSE:SNH), Health Care REIT (NYSE:HCN), HCP (NYSE:HCP) and Ventas (NYSE:VTR) all down 12% or more in the past month. So much for the efficient market hypothesis!

In looking at these stocks in the aftermath of this carnage, I believe that there is short-term trading opportunity to the upside as these shares consolidate their losses and expectations of Armageddon diminish. However, the pricing of public SNF shares in a range of 8 to 10 times, expected, forward earnings seems the best one can hope for.

Looking forward, I am very pessimistic about the industry. Despite a rapidly aging population and a compelling story as the low cost provider of sub acute nursing care, skilled nursing facilities are under tremendous pricing, cost and regulatory pressures – from the OIG, Medicare, Medicaid, plaintiff lawyers, RAC auditors and various inflationary pressures. The once high expectation of relief via health reform initiatives seems to have given way to SNF’s occupying the least well positioned seat at the bargaining table when it comes to Accountable Care Organization bargaining and pricing.

Furthermore, in the current federal debt and budgetary climate, one must remember how far our government has gone in the past to wring costs from the health system. Eventually, our public payors like to extract any remaining margins from the system, just look at our hospital system. As a long-term industry buyer once said, “the nursing home industry once was dominated by non profits and one day it will be again.”

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: An Opportunity in Healthcare Stocks