Future Looks Bright For Home Healthcare Companies

Includes: ADUS, AFAM, KND
by: Harold Goldmeier

Home healthcare services are an alternative to high cost institutionalization of aging and special needs populations. An attractive alternative to states with tight budgets.

Home healthcare stocks are relatively undervalued have room to grow.

M&A is picking up speed in a fragmented industry with 7,000 providers dominating 96% of revenue collections.

I recently wrote for Seeking Alpha readers that the nursing and retirement center home industry is a solid investment. Profits are staggering. The target markets are the aging population and people with special needs. Both are growing and there is a cultural demand to spend more on their quality of life and care. Home health care is a stepchild of the industry often underestimated and overlooked.

Institutionalizing people is very expensive estimated by AARP to cost upwards of $50,000 per year per patient. Medicaid and Medicare are the primary payers. In an effort to save money, increase chances for patients returning to independent living, and keeping families intact there has been a push over the last few decades to move the terminally ill to hospice care, and whenever possible others into home health care. A network of companies sprouted providing medical and personal support services to patients at home.

Services eligible for reimbursements are short-term nursing, rehabilitation, therapies, and assisted living provided by registered and licensed practical nurses. Physical and occupational therapists make home visits, as do medical social workers, and speech pathologists working with stroke victims and pediatric patients. Home health aides and care givers are the largest number providers of daily care, because patients need assistance with bathing, eating, and cleaning. There are families able to afford additional care providers like private duty nurses they hire through agencies.

Dexter Braff reports on the increase investor interest in home health care from private equity groups. Braff alerted investors two years ago the home health sector is "relatively undervalued." The industry supports more than 7,000 companies primarily comprise of small family-owned firms. The publicly traded companies generate only four percent of the revenues.

Braff suggests there is room for profit growth in home healthcare. Services provided by hospitals struggle for profitability, because of the inherent high cost infrastructure and the importance of maintaining a top quality service delivery image enhancing their brand. The industry is not technology driven in ways to contain costs. Home health companies must compete with nursing homes and hospitals for patients with limited marketing dollars to generate more patients. The fragmented industry benefits from private equity activity that pushes for going public and growth through consolidation.

In January 2015 it was announced that Chicago based Addus HomeCare Corp (NYSE: ADUS) acquired a Cleveland home health company with $11m in revenues. ADUS acquisition strategy is to buy in states "planning the near-term transition of care to managed care organizations." The market cap is $310m, so there is a lot of room for price share upside. Revenues y/y grew by 14.3% for the first quarter reaching nearly $82m. The company offers a full range of home healthcare services including social activities, elderly day care centers, and transportation. It operates in 22 states. ADUS enjoys a profit margin at 3.73% and an operating margin of nearly 6%. It holds more than $7m in cash. ADUS is a solid company trading near its high at $28 per share and is a buy especially if states continue to pull themselves out of debt and stay on the path of home care.

Almost Family Inc. (NASDAQ: AFAM) is a home health provider of nursing, rehab, and personal care services in business for more than thirty years. Last June the stock traded in the $21 range, hit a high over $49 on steady growth and solid volume, and now trades at about $37 per share. The market cap is $365m. Zacks recently gave it a strong buy rating. I believe it has the capacity to hit a target price near $50 in the near future. BlackRock Fund and Dimensional Fund Advisors hold more than ten percent of the stock. Fidelity funds hold another 12 percent.

Just to reemphasize the M&A moves in the home healthcare industry, in February 2015 Kindred Healthcare Inc. (NYSE: KND) acquired Gentiva Health Services valued at nearly $2b. Gentiva was the nation's largest provider of home health, hospice and related services with more than $1.7b in revenues. Gentiva operated through more than 270 locations across 39 states. Gentiva's stock price performed poorly, but the company had a very healthy 44 percent gross profit margin.

KND operates post-acute and transitional care hospitals, rehab and nursing centers, and pharmacy services. It ranks 410 in the Fortune 500 list of companies. "By providing patient-centered, coordinated care at home and across the Continuum of Care," the addition of Gentiva makes KND the largest home health and hospice care provider in the U.S. KND serves more than 1m patients per year, over 47 states, employing more than 105,000. Management expects to reduce costs and improve quality of care and clinical outcomes. The acquisition diversifies revenue mix, revenue and margins will benefit, and balance sheet and cash flow will strengthen.

KND stock price trades near $23 per share down about 12 percent from its 52-weeks high in part from the dilution to fund acquisitions. It has a 1.9b market cap, has revenue growth of 32% to $1.68b, and pays more than a two percent dividend yield. The consensus price target for KND is $30.50. Its total return YTD is 26%. Deutsche Bank initiated a buy recommendation in March. Significant institutional holders of stack include some of the same companies investing in AFAM.

An owner operator friend of mine in the healthcare services industry made me aware of three caveats for investors when I told him about my articles.

First, states are still suffering liquidity problems. Illinois cut the Medicaid reimbursement rate 12.6 % for May and June, and July 1st fiscal year is yet unknown. Gross income is affected but operating expenses are difficult to cut. Providers must meet quality care standards and new regulations.

Second, the states are "pawning off" their caseloads to managed care insurance companies. Billing and collections protocols are more complex. We are now dealing with around eight managed care insurance companies in addition to the State of Illinois. Each company has its own system of authorizations, billings and payments. Some are not accepting a social worker's recommendation for nursing or home healthcare. They want operators to get prior preauthorization.

The other challenge providers face is finding CNAs for what is a fairly low paying job, because of reimbursement rates. It is also hard to find good nurses. CNAs and nurses make up of the bulk of our employees and payroll expense. Nevertheless, society will no longer tolerate scandals and lax care for the infirm and special needs populations. Publicly traded providers are on the right-side for the long term of compassion for the vulnerable and fierce censoriousness toward politicians eviscerating the social safety net.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.