- Chemed provides exposure to two very different divisions: Hospice care and plumbing.
- The share price recently fell by over 20% as the market was getting a little bit ahead of itself.
- Chemed is still expensive, but the valuation is relatively reasonable now.
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Chemed (NYSE:CHE) acts as a holding company for two completely different divisions. It owns VITAS Healthcare which is one of the largest hospice care companies in the US while the Roto-Rooter providers plumbing and drain cleaning services to residential and commercial customers.
Source: Company presentation
Both divisions couldn’t be more different from each other but they have one thing in common: They are resilient, even during tough economic times. That’s why the company is trading at high multiples, but those high multiples aren’t necessarily unreasonable.
The FY2020 results were stellar…
Before explaining how a bunch of non-recurring items has impacted the Chemed full-year results, we should first have a look at said FY 2020 results. The company reported a revenue of $1.08B, an increase of approximately 7% compared to FY 2019. The COGS increased by just 4% and this helped to improve the gross margin.
As you can imagine, the G&A expenses increased as there's a correlation between the business expansion and the overhead expenses, but the total amount of costs and expenses increased by about 0.5% compared to 2019. The main reason for this relatively low increase is the $75.1M in "other income" reported. This pushed the operating income much higher to almost $390M.
Source: SEC filings
The pre-tax income of $396M and net income of $319M is substantially higher than the $262M and $220M in FY 2019 and the slightly lower average share count pushed the EPS to $20.02, coming from $13.77/share.
An excellent result, but the $75.1M in "other operating income" was the main reason for the strong performance in 2020, and the footnotes explain the majority of the $75.1M benefit was caused by an $80.2M contribution from the CARES Act benefits.
Source: annual report 2020, footnotes
The cash flows reported by Chemed were also very strong, but those were obviously also impacted by the CARES Act benefits. The reported operating cash flow was $489.3M and after taking changes in the working capital position into consideration, the adjusted operating cash flow was $443.7M.
Source: SEC filings
The capex remains very low at just $58.8M, which results in a free cash flow result of approximately $385M or $24/share based on the 16.03M shares outstanding as of Feb. 12. A big chunk of the incoming cash flow was used to buy back stock: Chemed repurchased almost 385,000 shares at a total cost of just over $175M. The average price paid for the stock that was bought back was approximately $456/share. A good move, but this hardly made any difference as the company also issued new shares as part of the traditional stock-based compensation plans.
Source: SEC filings
… But contained some one-time items, and 2021 will be worse
The 2020 results were absolutely amazing for a company with a very resilient business model. However, there is a catch as Chemed encountered a "perfect storm." CFO Dave Williams provides an excellent breakdown of the non-recurring items during the FY 2020 conference call:
One of the reasons, for example, there was 40 some odd million of the CARES Act money that we took as lost revenue that didn't have any costs attributed to it. So, on a pretax basis that was pure cash flow.
In addition, we had about a little under $40 million of deferred payroll taxes for the Chemed consolidated. So we don't have to pay the employer portion of payroll taxes until half of that gets paid in December of 2021. The other half in December of 2022 so that's spike of cash flow, another $40 million say roughly. And then you had, of course, sequestration, which is real, but we don't expect that to continue that's by cash flow another $18 million. So really take away, call that by the $110 million or so out of the 2020 cash flow.
So the guidance for 2021 may perhaps be a bit disappointing for anyone who thought the FY 2020 performance was the normal course of business. For 2021, Chemed is guiding for an EPS of approximately $17-17.5/share assuming an effective corporate tax rate of 24.7%. The Roto-Rooter segment will have a mid single digit revenue growth but the VITAS division will likely show a lower revenue this year.
Source: Annual report
This means the recent share price correction from over $550 to the current level of under $430 shouldn’t have come as a surprise as the company was trading at over 30 times its 2021 earnings. Investors likely got a little bit ahead of themselves by the strong performance in 2020 but didn’t fully realize the 2020 results were boosted by non-recurring items. At the current share price of just under $430, the stock still isn’t cheap as it still is trading at about 25 times the mid-point of the 2021 earnings guidance. The free cash flow (excluding the impact from stock options and share-based compensation) will likely come in at around the same level, for a free cash flow yield of 4%-4.5%.
That’s low, but given the resilience of the sectors Chemed is operating in, it’s not per se unattractive. I currently don’t have a position in Chemed but could be interested in initiating a long position.
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