Providence Service Corporation: Up to the Task

Aug.23.07 | About: The Providence (PRSC)

Providing services for those in difficult straits doesn’t seem like a popular business, and it isn’t. But it can be a profitable one, particularly when handled by Providence Service Corp. (Nasdaq: PRSC).

Providence delivers privatized social services in clients’ homes or communities; the company does not own any hospitals, correction facilities, treatment centers or group homes. Providence seeks business through state and local government initiatives, offering foster care and home- and community-based service alternatives in adult and juvenile justice, corrections, welfare systems, and Medicaid. As it continues to find room for more services, the company moved into the in-home tutoring space, workforce development and private probation services markets through several acquisitions completed in 2006.

Since its founding in 1996, Providence has grown from 1,333 clients to more than 70,000 in 318 locations in 36 states and the District of Columbia. Headquartered in Tucson, Ariz., the company now has market capitalization of $348 million.

Just this month, Providence began operating in Canada by buying workforce-trainer WCG International Consultants Ltd., a Victoria, British Columbia-based company. Providence sees Canada as a growth spot, considering the country’s liberal benefits—including those for job training—and robust economy. There also are few if any home-based providers in western Canada, CEO Fletcher McCusker said on the second quarter conference call earlier this month. The company looks for other opportunities in British Columbia and in other provinces.

In the United States, there’s good reason to expect more growth. The trend is toward privatization of government services, and larger numbers of people are becoming eligible for these services because of income, emotional or educational disabilities, or court orders.

The trend also is away from providing services in institutions, given costs and the growing number of offenders and at-risk populations. From various sources, included in Providence’s annual report:

  • 37.0 million people were living in poverty in 2005 and 2004, up from 35.9 million in 2003
  • 46.0 million people were enrolled in Medicaid in 2005
  • 33% of students failed to attain high school diplomas in 2006
  • 2.1 million juvenile arrests were made in 2005
  • More than 4.9 million adults were released under probation/parole programs at the end of 2005
  • As acceptance of the cost benefits to privatization grows, so too will Providence’s business. The company says, for example, that certain states have now chosen to completely privatize delivery of Medicaid services, and believes other states will follow. Federal spending on the Medicaid program was estimated to reach approximately $192 billion for fiscal year 2006.

    All this adds up to great reasons to expect more profits and a new high in Providence’s stock. The company released second quarter results August 8, showing a revenue gain of 36% to $562.3 million as of June 30. The increase was led by an advance of 45% in home- and community-based services, which dominates Providence’s business (its other two reporting categories are foster care services and management fees). Earnings in the quarter were $0.30 cents per diluted share, up from $0.28 a year earlier.

    Success so far this year—including winning certain contracts and acquiring WCG International Consultants—prompted Providence to raise previous guidance. It is now looking for revenues of $251 million to $253 million in 2007, up from prior guidance of $245 million and up 32% from 2006. Diluted earnings per share are expected at $1.17 to $1.19, up from $0.80 in 2006.

    Heady growth. Yet shares, looking as if they’re set to take on a new all-time high, are doing so priced at a down-to-earth 25 times the company’s 2007 earnings forecast, and 20 times the $1.48 average analyst expectation for earnings in 2008. Having gone public in late 2003 under $15.00, Providence stock rallied to its high of $34.50 in April of last year. On Tuesday, shares closed at $29.64.

    Kevin Campbell, an analyst at Avondale Partners, raised his 2008 earnings to $1.52 after absorbing second quarter earnings, and raised his price target to $34.00. “With fundamentals remaining strong and a number of positive catalysts on the horizon, we maintain our Market Outperform rating on shares of PRSC,” Campbell said in a research note. He said the $34.00 price target reflects 15% organic revenue growth that he expects to be supplemented by Providence winning new contracts and making acquisitions.

    Catalysts include the potential for a contract in Maricopa, Ariz., with Magellan Health Services Inc. (Nasdaq: MGLN) and other opportunities in California, North Carolina and Pennsylvania. Campbell also figured that Providence had $19 million at the end of the quarter that could be used for further acquisitions.

    While many companies do not want to get involved in home- and community-based social services on a national level—it is a low margin business prone to risk from negative headlines—Providence has lots of local competition, much of it coming from non-profits such as Catholic Social Services, Jewish Family and Children’s Services, and the Salvation Army.

    National companies whose tasks overlap those of Providence include Res-Care, Inc. (Nasdaq: RSCR), which provides job training and educational services, Psychiatric Solutions Inc. (Nasdaq: PSYS), which owns facilities and provides inpatient behavioral healthcare services; and Cornell Companies, Inc. (NYSE: CRN), which owns prisons and provides rehabilitation services. The broad category of health care services rose 15.8% annualized in the past three years, compared with Providence’s gain of 33.0%.

    The market for providing privatized services remains competitive. And, although lean budgets may favor home-based programs, across-the-board budget cuts would hurt Providence, as would the inability of the company to continue to make profitable acquisitions. Government employee unions also could put political pressure on officials who would like to privatize government programs, which would limit the company’s opportunities.

    To continue its strategy of expanding services, growing organically and pursuing strategic acquisitions, Providence needs to show it can grow gracefully. Business development the past ten years has been great in both size and complexity, and this is putting big demands on Providence’s management systems, internal controls and financial and physical resources, as the company notes in its annual report.

    Caveats considered, the focus is still on growth, growth and more growth. And that is one job Providence has shown it can do very well.

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