It's an old investing axiom that you can make money when stocks
are hated. The rule also applies to the broader stock market and
beaten-down sectors. It always pays to check out stocks and sectors
that have sharply fallen to see if emotion-based selling has pushed
them so far down that they have become true bargains.
This year's poster child for investor loathing is the home health
sector, which has been dogged by
Securities and Exchange Commission (SEC)
investigations, profit-sapping reimbursement changes from Medicare,
and management teams that appear flat-footed. Yet looked at in
another context, the home health care sector should hold great
appeal, thanks to the rapid aging of our society and the fact that
treating patients in their home is always far more cost-effective
than treating patients in a hospital. It's quite possible that
near-term pain may well yield some impressive long-term gains for
these unloved shares.
These stocks include
Amedysis (Nasdaq: AMED)
Gentiva Health (Nasdaq: GTIV)
LHC Group (Nasdaq: LHGC)
Almost Family (Nasdaq: AFAM)
. All of these stocks have lost -35% to -55% of their value in the
last six months. Their troubles began in late April when
The Wall Street Journal
reported that some home health-care providers -- most notably
Amedysis -- were pushing for extra home care visits in order to
meet a Medicare-induced threshold that awarded bonus reimbursement
fees. Two weeks later, the Senate invited company executives to
come and testify.
That was followed up with a July 1 announcement of an SEC
investigation. As a final kicker, Medicare announced that it would
cut reimbursement for home health care visits by roughly -5% in
2011 and by a similar amount again in 2012.
For investors, it's time to separate the one-time problems from the
long-term impacts. In the near-term, the SEC may issue some pretty
steep fines for overbilling. Amedysis appears to be the most
egregious violator, and could face the steepest fines. And Medicare
is likely to change reimbursement rules in order to remove the
incentive for too many home health care visits. As it stands,
Medicare is taking much longer to re-certify patients that have
already been receiving home health care visits. That could have a
fairly immediate impact on near-term results, although it's curious
to note that 2011 profit forecasts for these firms have barely
budged in the last 90 days. Forecasts will need to come down before
these stocks are safe to buy.
For some investors, those -5% reimbursement cuts in 2011 and again
in 2012 are the main reason to avoid this sector. Those cuts may
seem onerous, but still leave ample room for profit. These
providers can bill roughly $250 for each visit, though it only
costs them about $80. So they can easily handle some price cuts.
These companies typically had 55% gross margins and 15% operating
margins. Gross margins in the high 40s and operating margins may
become the "new normal." That's still fairly impressive --
especially when you consider that demographic changes should lead
to steadily higher patient volumes. And these companies have ample
means to buy their way into growth as this remains a very highly
fragmented industry with roughly 10,000 players.
Action to Take -->
The sharp fall in sector shares means that all of these stocks now
sport single-digit price-to-earnings (PE) ratios. Yet there's no
reason to rush out and buy shares simply because they are cheap --
especially since we haven't heard the last of the SEC
investigations. Instead, this is a sector to watch and prepare to
move in when the time is right.
As noted, Amedysis looks to be the most egregious violator of
billing practices, and its shares should probably be avoided, no
matter what. Gentiva Health may also see more troubles as it may be
unable to raise the funds to pay for its May, 2010 $1 billion
acquisition of Odyssey Health care.
In contrast, Almost Family looks fairly appealing thanks to its 50%
revenue concentration in increasingly geriatric Florida, apparently
cleaner billing practices, and a relatively strong
which should fuel acquisitions. LHC Group is also seen as a
relatively clean operator and management has a strong track record
of garnering strong returns on invested capital. Both of these
firms trade for about eight times projected 2011 profits.
Whenever a sector has been badly-bruised, you have nothing to gain
by being the first one to wade back in. Instead, I prefer to see
these shares start to rebound a bit -- perhaps +10% to +15% above
current levels. Sure you're leaving some upside on the table, but
at least you avoid waiting for several quarters before seeing your
investment start to appreciate.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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