Providence Service Corporation: Underfollowed, Undervalued Medical Transportation Play

Summary

• Providence is poised to deliver low- to mid-teens revenue growth on the back of increasing medical transportation demand and acquisitions.
• Profits should grow even faster as margins expand, thanks to various cost saving initiatives currently being implemented.
• The company’s shares currently offer a very attractive risk/award opportunity with 45+% upside potential over the next 12-24 months.

Benjamin Franklin once said, “In this world nothing can be certain, except death and taxes.” If Ben were alive today, he’d probably add a third certainty to his list: rising healthcare costs. Indeed, despite decades of efforts to control costs, spending on healthcare continues to increase, almost exponentially. And there’s no indication that this trend will reverse for the foreseeable future. One of the few publicly traded companies doing something to combat this very serious problem is Providence Service Corporation (PRSC).

Business

Providence operates via two segments. A little over 80% of its revenue comes from non-emergency medical transportation (or NEMT), while the balance of revenue comes from workforce development (or WD). This report will primarily focus on the core NEMT segment.

Providence is the largest provider of low cost non-emergency medical transportation in the US. It provides over 190,000 trips per day – 70 million trips per year – to over 26 million riders in 39 states plus DC. These riders are primarily disabled or poor Medicaid/Medicare recipients who need to get to and from medical services, but have no means of transportation.

The economics of this business are very attractive for three reasons:

• First, it’s asset-light and scalable. Unlike a traditional NEMT company, Providence doesn’t own any vehicles and outsources the actual transportation to local cab, van, and ambulance companies. Its role is to process calls, handle billing, supervise the service quality, etc. This is essentially the same business model employed by Uber.
• Second, competition is generally weak. Economies of scale allow Providence to be very competitive pricewise, preventing most competitors from underbidding it on a contract. This is a key reason why its customer/contract retention rate exceeds 90%.
• Third, revenue is highly predictable. Around 80% of Providence’s NEMT contracts are capitated, meaning it gets paid a set rate rather than on a fee-for-service basis. The only real risk here is that profitability can fluctuate significantly depending on service utilization. So far this hasn’t been a major problem.

Growth

Providence’s revenue growth rate has historically hovered in the 10-15% range, mainly driven by acquisitions and new contract wins in the core NEMT business. Management targets a 6+% CAGR going forward, which excludes potential M&A. This projection seems very conservative given current trends. Like the aging population and the need to reduce healthcare spending.

By 2030, some 73 million US residents are projected to be 65 or older, up from 40 million in 2010. With age come health problems. With health problems, come more visits to the doctor. In fact, the average 65-plus year old makes six to seven trips to the doctor each year – that’s more than three times as many as the average 18 year old. This visit frequency will almost certainly increase in the coming decade as diabetes, cancer, heart disease, and other chronic diseases continue to skyrocket. Which means healthcare spending – fast approaching 20% of GDP – will need to be slowed.

One way to accomplish this is by keeping the aging and sick in their homes for as long as possible. Efforts here have had some success, evidenced by the fact that the average nursing home occupancy rate has decreased from 85% to 80% since the mid-1990s. This decline has occurred despite an unprecedented growth in the older population, especially those in the oldest age categories – the group most likely to need Medicaid long-term care. This is the key ongoing trend that should boost demand for Providence’s transportation service in the coming years.

M&A is another potential growth driver. In the past, acquisitions accounted for roughly half (or 5-7%) of Providence’s annualized growth. This is unlikely to change going forward. Management has said that they’re looking into buying businesses with similar characteristics to NEMT. With a cash-rich balance sheet and minimal debt, the company has plenty of dry powder to make a needle-moving deal. This could easily push its revenue CAGR into the low- to mid-teens.

Profitability

Providence’s consolidated EBIT margin has historically fluctuated around the 2-4% range. In an effort drive margin growth, management set out in 2016 to optimize the company’s transportation network and restructure its currently unprofitable WD business. While these initiatives have eaten up a substantial amount of capital and hurt short-term profits, the good news is that most of the heavy lifting will be completed by year’s end. Annual cost-savings are expected to exceed $50 million, which should drive Providence’s EBIT margin into the mid- to high-single digits in 2018/19.

In addition to the cost saving initiatives just mentioned, there are a few of other non-recurring items that have hurt Providence’s profitability during the last 12 months. The largest of these was a $21 million impairment charge in the WD segment, primarily related to lower than expected volumes under a large contract in the UK. All one-time items combined totaled $35.8 million. Adding this back gets us an adjusted EBIT of $42.2 million. This figure presents a much more accurate picture of Providence's true earnings power.

Sources: A North Investments, company reports

Valuation

At an enterprise value/adjusted EBIT of 16.5x, slightly below peers’ median of 17.5x, Providence by no means looks like a bargain right now. However, we need to account for growth. When including potential acquisitions, Providence’s long-term revenue CAGR could likely reach into the low- to mid-teens. Its EBIT CAGR will almost certainly exceed this when cost saving efforts start to pay off in early 2018. A $75 million to $100 million EBIT is very achievable by 2019. That would make this stock a steal at the current valuation.

Notes: 1) Enterprise value = market cap - cash and liquid investments + total debt and capital leases + preferred stock + minority interest; 2) peers are long-term profitable medical services and transportation services companies; sample size is 20 companies; 3) EBITs exclude significant non-recurring items.

Sources: A North Investments, company reports

That said, what’s Providence’s fair value? A very conservative estimate would be 20x enterprise value/adjusted EBIT (a ~14% premium to peers). That translates to a fair value of $61.30/share. But we aren’t done yet. We still have to add the value of Providence’s Matrix investment, which isn’t included in its revenue and EBIT numbers. In late 2016, Providence sold a 53.2% share of Matrix, a provider of home-based medical assessments, to investment firm Frazier Healthcare Partners. It sits on the books at a value of $157 million. But it’s worth much more than that right now.

Here’s a brief financial summary for Matrix on a standalone basis:

• Generated $222 million in trailing 12 month revenue; growing in the high single-digits.
• Generated $25 million in trailing 12 month EBIT (excluding non-recurring items).
• Has $180 million of net debt; steadily getting paid down via free cash flow.

Frazier originally paid about 22x EBIT for its majority stake. Applying this same multiple to Matrix’s current EBIT, subtracting out the net debt, and then applying Providence’s 46.8% ownership, equates to fair value of about $173 million (~10% above the book carrying value). Adding this $173 million figure to our original fair value estimate brings the total fair value to $74/share, which represent over 45% upside from recent price levels.

Conclusion

Providence is poised to deliver low- to mid-teens revenue growth on the back of increasing medical transportation demand and acquisitions. Profits should grow even faster as margins expand, thanks to various cost saving initiatives currently being implemented. This should drive Providence’s shares significantly higher from current levels. Upside of 45+% over the next 12-24 months is very possible.

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Disclosure: I am/we are long PRSC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.