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My favorite stock in the health care sector and one which is a top 3 holding in the portfolio is Advocat (NASDAQ: AVCA). Advocat operates nursing home facilities in eight states with the largest concentration of facilities in Texas and Arkansas. The company acts as one of the very few pure-play companies in the nursing home industry.

The nursing home industry has become more consolidated over the past decade as the sector had a very difficult period in the late 1990s due to high costs for litigation and uncertainty revolving around Medicare and Medicaid reimbursement rates. Over the past 5 years, industry fundamentals have significantly improved due to consolidation within the industry, less litigation costs due to caps and stronger reimbursements from Medicare and Medicaid.

In fact over the past 10 years, despite an aging population, the number of nursing home facilities has actually declined, thus increasing the occupancy rates of many of the still standing operators. Advocat has been undergoing a restructuring over the past several years which has left the company in much better shape financially with strong operating cash flows and free cash flow generation, increasing occupancy rates (the company still has significant upside potential in this area) and much improved nursing home facilities.

The improvements and renovations of the nursing home facilities should lead to significantly improved occupancy rates over the intermediate to long term. The company when offered the opportunity has made strategic acquisitions of nursing home facilities. The most recent acquisition was of facilities in Texas at a price of just 4x EBITDA. In my opinion, the stock is trading at a very attractive valuation of about 10x my own estimates for earnings over the next year, has strong operating cash flows and is trading at about 8x FCF. For a detailed analysis of the stock that I wrote for subscribers in November please click here.

Source: Advocat: Compelling Opportunity in the Health Care Sector