Another Strong Quarter for Advocat

Advocat (AVCA), an operator of nursing homes and the second largest holding in the portfolio, reported another strong quarterly report in this past week due to strong top-line and bottom-line growth along with higher acuity levels among their patients. The EPS figure came in at 50 cents per share, easily surpassing the sole analyst's expectations of 22 cents, with top-line also beating estimates.

In the company's conference call,they mentioned that they anticipate some carry forward in revenues from the prior quarter due to the continued improved acuity mix and the longer flu season this year. Medicare revenues increased to nearly 12% due to the higher acuity levels where increased emphasis on pain management and improving the experience of patients has helped fuel growth.

The company continues to look for potential acquisitions but are holding strict to not paying more than 4-6x EBITDA for these centers. Over the past couple of years, Advocat has been undergoing a process where they are renovating their facilities to improve the look and facility options. As of last week, the company had completed 8 renovations with an additional 2 renovations expected to be completed in the third quarter, and the likely announcement of a couple more renovations in the next six months.

The stock has been relatively stable over the most recent few months, however before that time, the stock had reached $20 in October 2006 and then sold off after a couple of more difficult earnings reports and the announcement that the company had turned down a bout offer.

Over the past several months, the company has come under increasing pressure from shareholders to unlock some of the value. In the past five months, the company bought back over 200,000 shares for $2.5 million, has made strategic acquisitions of nursing homes and has now placed on the ballot (under pressure from some activist shareholders such as Bristol) for their annual meeting an initiative to explore strategic alternatives, including the potential sale of the company.

The stock trades at an inexpensive valuation with a p/e of under 8, p/cf of less than 6 (industry average closer to 10 or more), p/s of 0.3 and a ROIC of greater than 20%. Although the purchases have been relatively small, the CEO, COO and CFO have all bought some shares in the past couple of months.

Where will Advocat go from here? It's difficult to say how the stock will react in coming months, but with the very inexpensive valuation, excellent growth prospects, recent share buybacks and potential search for strategic alternatives the stock could potentially have significant upside in my opinion from current levels just above $11 per share.

Disclosure: Author owns shares of AVCA.