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LHC Group And Amedisys: Industry Overview (Home-Based Care)

|About: Amedisys, Inc. (AMED), LHCG
Summary

This industry overview is used as a backdrop for the explanations of my pair trade (separate postings).

The pair trade involves shorting an equal amount of Amedisys as I am buying of LHC Group.

This blog post is part of three related, simultaneous postings on SeekingAlpha. The below industry overview summarizes important developments and trends in home health since I first covered the industry in a series of seven articles over a decade ago. Readers with a basic understanding of the healthcare sector and home health industry should skip this blog post, as they will benefit more from the published article, “Long LHC Group” (a dry, number-crunching published article), or “Great Pairs” (a more playful blog post). Both the published article and the blog post focus on the same subject: pairing LHC Group (long) and Amedisys (short).

My articles from ’08 and ’09 on the home health industry focused on four of its publicly traded companies: Almost Family (AFAM), Amedisys (AMED), Gentiva (GTIV) and LHC Group (LHCG). My recommendation in that series was to buy and hold any/all of those volatile publics at the prices they were then trading at. In the last of those articles, I wrote, “If we buy these stocks fully aware of the long-term opportunities, then we can regularly reflect on the intrinsic value of these companies (or go on a sabbatical to the Congo) rather than focus on erratic and inefficient stock market quotations in the short term.”

I then took an extended sabbatical from writing SeekingAlpha articles, but I never made it to the Congo. Instead, I loitered within the domestic economy, training my brain on commercial insurance, legislation at the state level, the death care industry, escape rooms, private equity and the gig economy. That last subject has already sparked a new series for SeekingAlpha: During our next recession—whenever that is—readers should expect articles and recommendations from me on the cyclical contingent employment industry.[1]

But for now, we’re focusing on home health! Our four publics have performed very nicely since my original recommendation (April ’09). While the S&P 500 is up about 11.7% CAGR since thenabouts, our four publics have logged 18%-ish CAGR.[2] The broader landscape in home health has changed over the past decade, and the remainder of this article should bring readers up to date.

Since 2009, From 30,000 Feet

The overly complex U.S. healthcare sector accounts for an outsized 17+% of our GDP (about $3.7T in 2018). To simplify the concept of home-based care, let’s first ignore products (medical equipment, pharmaceuticals and other goods) and administrative expenses found in this daunting sector and consider only services, which, in broad terms, are delivered via inpatient (think traditional hospital) or outpatient (think non-overnight) approaches. Outpatient care (aka ambulatory care) is diverse: clinics, surgical centers, physician offices, telemedicine, home-based care.

The elaborate collection of payors for healthcare can also be approached simply if we use just four buckets (see p. 8 here): private insurers[3] ∼32% ($1.18T), Medicare ∼19% ($.7T), Medicaid ∼18% ($.67T), and other[4] ∼31% ($1.15T). Private insurers number in the hundreds and limit communication with each other due to competitive pressures. As such, it is difficult for this group to agree on anything, much less lead the industry. To a lesser extent, the same applies to Medicaid, which is jointly administered by the federal government and dozens of disparate states and jurisdictions. Because of its singular girth and inertia, therefore, Medicare sets the tone for all payors. Moreover, as in-home patients are predominantly elderly and citizens over the age of 65 automatically qualify for Medicare entitlement, Medicare is the 800-pound gorilla in the home-based care space.

Although healthcare spending has increased dramatically over the past four decades (see Figures 1 and 2), home health is the only service-providing industry that has increased its portion of the rapidly expanding healthcare pie (from 1%—or a measly $1B—in 1976, to 3%—or $92B—in 2016),[5] and this trend will continue. Demographics have shifted greatly in favor of the home-based care industry. In the prime age bucket of 75- to 84-year-olds, our population has grown about 18% over the past 10 years, with even more stunning growth to follow (see p. 4 here).

Figure 1

Figure 2

Separate from but amplifying demographic trends is the health care sector’s systemic shift away from institutions toward ambulatory care. Though exact figures are difficult to obtain, I estimate that over the past 10 years, total inpatient revenue has increased from $700B to approximately $900B while outpatient has grown much more quickly from $1.4T to $2.1T. The shift away from inpatient was easy to see ten years ago when the ACA was passed. Outcomes were improving in ambulatory care, and each of its venues cost a fraction of institutional settings. Again, home health is leading the charge here as the total number of users in the past decade has grown 33% from 3M to 4M and total Medicare revenue has increased about $33B (49%) to around $100B.

In The Triple Aim: Care, Health and Cost, published around the passage of the ACA, Berlin, Nolan and Whittington boiled the zeitgeist of U.S. healthcare intelligentsia down to three goals:

  1. Improve the patient experience of care (including quality and satisfaction);
  2. Improve the health of populations; and
  3. Reduce the per capita cost of healthcare.

Those goals for the broad healthcare sector create great tailwinds for the home-based care industry, as it is widely understood that patients generally prefer medical treatment at home, and home is the least expensive medical venue.

In their scholarly article, The Future of Home Health Care: A Strategic Framework for Optimizing Value, Landers, Madigan and Leff synthesize various inputs from the healthcare sector—with emphasis on relevant legislation—over the past decade that stem from those three goals. In a nutshell, frugal payors of healthcare (led by Medicare) push towards incenting quality rather than quantity.

Figure 3

2008

2009

2012

2013

2014

2015

2018

2019

Legislation Passed

MIPPA

ACA

PAMA

MACRA

Program Implemented

ESRD-QIP

BPCI

HAC

VM

SNF-VBP

HH-VBP

APMs

MIPs

HVBP

HRRP

CJR

Legislation

ACA: Affordable Care Act

MACRA: the Medicare Access & CHIP Reauthorization Act of 2015

MIPPA: Medicare Improvements for Patients & Providers Act

PAMA: Protecting Access to Medicare Act

Program

APMs: Alternative Payment Models

BPCI: Bundled Payments for Care Improvement Initiative

CJR: Comprehensive Care for Joint Replacement Model

ESRD-QIP: End-Stage Renal Disease Quality Incentive Program

HACP: Hospital-Acquired Condition Reduction Program

HVBP: Hospital Value-Based Purchasing Program

HHRP: Hospital Readmissions Reduction Program

MIPs: Merit-Based Incentive Payment System

VM: Value Modifier or Physician Value-Based Modifier (PVBM)

SNF-VBP: Skilled Nursing Facility Value-Based Purchasing Program

HH-VBP: Home Health Value-Based Purchasing Program

Source: The Future of Home Health Care: A Strategic Framework for Optimizing Value, Landers, Madigan and Leff

This emphasis on qualitative rather than quantitative outputs means that value-based purchasing (VBP) will become a bigger player in home health. Home health providers stand to gain greater profits (or foot bigger losses) dependent upon qualitative assessments of outcomes. VBP, the Home Health Groupings Model, the Patient-Driven Groupings Model (inclusive of its behavioral adjustments) as well as other universal regulations and payment models are all offspring of the aforementioned three goals of Berlin/et al. This all bodes well for our publics in two easy to see ways. First, more patients will be sent towards the home health industry generally. Second, the increased focus on quality reporting and quality outcomes (with their inherent reliance on technology) creates barriers to entry that benefit a group of larger firms that continue to take incrementally greater shares of the market.

Shifting gears to market participants, the home health industry has historically been dominated by small firms—especially of the mom-and-pop variety. This seven-article series (linked) that I wrote a decade ago provides historical context for the home health industry through 2009. While that series addressed home health as a whole, I still focused on four publicly traded companies: Almost Family, Amedisys, Gentiva and LHC Group. At the time, those were the only noteworthy publics in this space. Those four as well as other larger players continue to gradually consolidate the market. In recent years, because of the high growth and profits this industry promises, it has attracted some big money. Private equity (PE) continues to pour into home health and presents us with a mixed bag. On the one hand, PE’s influence should help home health improve its political voice, which has historically been a weak spot for this very diffuse and fragmented industry. On the other hand, PE brings with it a mindset of over-leveraging—which will contribute to or even cause a major disruption.

In "Technology, Nietzsche and Weapons of Mass Destruction," I observed that experienced executive teams in home health “shudder at the notion of exceeding long-term debt of 2.5 times EBITDA.” That is because they know how painful (and potentially bankrupting) large Medicare rate cuts have been and will be. PE firms are inexperienced in this space and frequently carry debt at 5, 6 and even 7 times EBITDA. They seem to borrow money in their sleep. (Inexperience is a recurring theme herein as well as the article, Long LHC Group.)

Beyond debt, I have heard anecdotal evidence of PE firms paying 13+ times EBITDA for home health firms—which helps explain the dearth of M&A activity from our experienced publics: The multiples being paid by PE are too dear. This will all end badly for PE firms. Ten years ago, I pointed out that when newcomers increase quickly (as they have in recent years), “it is quite likely that reimbursements have been too high, compelling various entities (often providers predominantly in other fields) to quickly charge into the profitable fray. This in turn compels Congress to reverse the trend by lowering reimbursements.” This point is even more important (and obvious) now than it was then.

It is hard to predict exactly when, but within the next ten years we’ll see Congress shake up this industry (which will present a wonderful buying opportunity of our publics). The familiar Congressional thinking goes something like this:

  1. We need money!
  2. Let’s squeeze some out of Medicare.
  3. Physicians, as a group, are very powerful, so we’ll let them skate.
  4. Hospitals, though on the wane, also have a powerful lobby.
  5. We’ll fleece the fragmented ambulatory care industries—let’s start with home health!

This does not mean home health admissions will slow or reverse. High admissions growth is a lock for decades to come. It does mean, however, that fiscal policy will soon enough lead to revenue and profit curtailment (as well as bankruptcies for many inexperienced and over-leveraged managers).

The private and public investments coming into home health over the past several years are not lost on CMS or Congress. They see the profits and valuations and think them excessive.[6] Of the near 13,000 home health agencies nationwide, a mere six big-monied firms (Kindred, Amedisys, LHC Group, Almost Family, Encompass and Brookdale)[7] control 18% of the market. While most of their shares are publicly traded, conspicuous PE firms like TPG Capital, Cressey and KKR have their fingerprints all over Kindred, Encompass and Amedisys, respectively. Since big money’s charge into the profitable fray has been anything but inconspicuous, it is now just a matter of time before Congress reacts.

Figure 4

National Rank

Agency Owner

National Market Share

1

Kindred Healthcare

5.85%

2

Amedisys, Inc.

4.54%

3

Encompass Home Health

2.43%

4

LHC Group

2.17%

5

Almost Family

1.70%

6

Brookdale Senior Living Solutions

1.37%

7

Trinity Health at Home

1.13%

8

Bayada Home Health Care

1.00%

9

Interim Healthcare

0.91%

10

Visiting Nurse Service of New York

0.85%

Source: LexisNexis

CMS recently offered this final ruling for reimbursements, which translates to nice increases for home health as an industry (2.2% for all of 2019, and an additional 1% in January 2020). Thus, the next several months offer all competent home health players an operational lock on success: high profits through at least early 2020. And we’ll have a good idea of what all of 2020 and early 2021 will look like by the beginning of July '19. Again, beyond this short-term reimbursement outlook, the long term is sure to bring high growth admissions. The problem: When will Congress slash reimbursements?

My pair recommendation (LHC Group long and Amedisys short) is designed to protect traders from such fiscal shenanigans as well as another bear market or recession or both.

To be clear, I am not picking on AMED (see my '09 pair trade recommendation). It is a fine company that will succeed long-term in this industry. In fact, I expect both of these companies’ share prices to increase before I exit the pair trade. But there are only two pure play companies left[8] in this industry to pair, and their current situations offer an opportunity too big to ignore. It just so happens that Mr. Market is misreading Amedisys' recent outperformance or LHC Group’s recent underperformance or (most likely) both.

Before analyzing AMED and LHCG in “Com-pairing” and “Great Pairs,” let’s grease the wheels with some definitions. The title of this posting invokes home-based care, which includes skilled nursing, personal care and hospice. While any payor can foot the bill for skilled nursing, all conversations regarding how Amedisys and LHC Group get paid start with Medicare’s reimbursement rates. Skilled nursing[9] typically involves a registered nurse or other such professional (think $130/hour charge) providing essential medical services at home as spelled out by a physician.

Personal care/assistance is typically reimbursed via Medicaid. Though important, these services can be provided by workers who are not highly skilled (think $40/hour charge). Services provided to beneficiaries include assistance with meals, hygiene, dressing, etc. While it is a commodity, personal care has demonstrated itself an important service offering for these companies to provide one-stop shopping for home-based care (and is soon to be reimbursed by Medicare Advantage).

In addition to personal care becoming much more important to these businesses, the higher-margin hospice—also reimbursable by Medicare—is a prized service offering in home-based care.

Understanding these three revenue buckets within home-based care will substantially aid our analysis as they account for over 90% of total revenues from LHCG and AMED. With this industry overview complete, the reader can now more easily tackle the formal pair trade recommendation (dense version linked here, playful version linked here).


[1] To any follower dedicated enough to read this blog post, I’ll tip my hand that BG Staffing is a buy under $24 as of 2/22/19 (subject to sensible caveats). As they are cyclical, contingent staffing stocks will be clobbered en masse whenever the market senses an imminent recession. But the core of BG Staffing’s business is either a-cyclical or counter-cyclical. Regardless, the market won’t figure that out quickly. Thereafter, BG Staffing will be one of the leaders out of the trough.

[2] Since April of ’09, Amedisys' stock price has grown at a 17% CAGR and LHC Group’s has averaged about 18% CAGR. Gentiva was purchased by Kindred in early ’15 while Almost Family merged with LHC Group in the spring of ’18. The latter two companies’ stock prices performed commensurately up until those transaction dates when their ownership was transformed.

[3] Private is used here to distinguish public resources such as Medicare and Medicaid from for-profit industry. There are, of course, hundreds of major medical health insurers with varying corporate structures. Some are traded publicly (e.g., Aetna), while others are held privately (e.g., EmblemHealth).

[4] Other encompasses a diverse set of payors: the Department of Defense; the Veterans Health Administration; individuals paying out of pocket; hospital trust funds paying uncollectible bills; donations. For our purposes, this bucket is not meaningful.

[5] See p. 10 of MedPAC’s March 2018 Report to the Congress Medicare Payment Policy.

[6] In the summary letter of MedPAC’s 2018 Report to Congress (see pages 5 and 6 here), home health is actually singled out (highlighted): “In this report, we continue to make recommendations aimed at finding ways to provide high-quality care for Medicare beneficiaries while giving providers incentives to constrain their cost growth and thus help control program spending. In light of our payment adequacy analyses, we recommend no payment update in 2019 for four [fee-for-service] payment systems (long-term care hospital, hospice, ambulatory surgical center, and skilled nursing facility) and reductions of 5 percent of the base payment for the home health and inpatient rehabilitation facility (IRF) payment systems.” Just because CMS and Congress don’t act on such recommendations for X years (where X = six, seven, eight or more) doesn’t mean they won’t act on them in year X+1.

[7] This 2017 list from LexisNexis has changed: Kindred was broken up and LHC Group merged with Almost Family.

[8] Publicly traded home-based care companies beyond the top 10 linked in the previous footnote include Vitas Healthcare, which is ultimately owned by Chemed Corporation, the owner of Roto-Rooter. Plumbing needs of our elderly notwithstanding, this is clearly not a pure play home-based care company. Getting closer to pure play status is Addus, but its focus on personal care is very different from LHC Group and Amedisys.

[9] Industry insiders sometimes use the nebulous term home health with two different meanings. The narrow meaning refers only to skilled nursing (aka, skilled home health). The broader meaning includes personal care. In this article, I never incorporate personal care into my use of the term home health. I do, however, use home health and skilled nursing interchangeably.

Disclosure: I am/we are long LHCG.

Additional disclosure: I am/we are Short AMED.