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The Microcap Speculator submits: Reader Phil suggested a while ago that I take a look at Advocat, Inc. (ticker: AVCA.ob), a small operator of nursing homes and assisted living centers. AVCA is an interesting pick. Last quarter it earned $.25 per diluted share. If it can maintain or improve upon those earnings, the valuation seems quite reasonable (even considering the $43.9 million of current liabilities). The company trades at an enterprise value to sales ratio of only 0.30, far less than its competitors. Getting to a normal EV/S ratio for the industry would result in a price per share gain of over 100%. Further appreciation could come from: (1) a sale of part or all of the assets; or (2) gains from reversals of self-insurance reserves, if the company has over-reserved as Phil and others appear to believe.

A few caveats. First, the self-insurance issue can cut both ways; one big verdict and all those reserves, and more, can be wiped out. Second, in its latest 10-Q, Advocat admitted that it faces severe financial risks over the next twelve months:

The Company has limited resources available to meet its operating, capital expenditure and debt service requirements during 2005. The Company has a net working capital deficit of $41.3 million as of June 30, 2005. The Company has $38.6 million of scheduled debt maturities (including short term debt, settlement promissory notes and current portions of long term debt) during the next twelve months, and is in default of certain debt covenants contained in debt agreements.

(clipped from pay service so I can't link -- sorry). So far the creditors have not squeezed the company, and usually in these circumstances the creditors will work wth the company so they do not compromise the value of the collateralized assets. However, the threat is there and if the creditors accelerate the debt, shareholders will suffer. Finally, as the company explained in the earnings release, Medicare reimbursement rules have changed in a way that will pressure margins a bit in 2006.

Bottom line: this stock will almost certainly move more than 50% in one direction or the other over the next twelve months. If I was a betting man, my money would be alongside Phil's on the long side.

I have no position in AVCA.OB. Not a recommendation to buy or sell any security. For informational and educational purposes only.

AVCA 1-Yr Chart