14 July 2009
Post Acute Care
Upgrading Sector View to
Positive from Neutral
Pito Chickering
Associate Analyst
(+1) 212 250-4817
philip.chickering@db.com
Darren Lehrich
Research Analyst
(+1) 212 250-2629
darren.lehrich@db.com
Sudeep Singh, CFA
Associate Analyst
(+1) 212 250-1394
sudeep.singh@db.com
Post acute bundling likely to be watered down in health care reform
Between the AHA's $155 bln agreement (which includes reimbursement cuts for
IRFs/LTCHs) and the most current House bill, we believe PAC bundling will be
substantially watered down in reform legislation. As such, a key overhang and
potential business model risk for PAC chains like HLS and RHB could be lifted,
thus making fundamentals matter again. To that end, we believe both HLS and
RHB are positioned well for market share gains, margin leverage and M&A in
2H:09. Upgrading both HLS and RHB to Buy from Hold.
Deutsche Bank Securities Inc.
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LOCATED IN APPENDIX 1. MICA(P) 106/05/2009
Forecast Change
Companies featured
HealthSouth Corp. (HLS.N),USD13.12 Buy
2008A 2009E 2010E
EPS (USD) 0.75 1.01 1.10
P/E (x) 21.7 13.0 11.9
EV/EBITDA (x) 6.4 7.4 7.1
RehabCare Group (RHB.N),USD23.54 Buy
2008A 2009E 2010E
EPS (USD) 1.15 1.72 1.96
P/E (x) 15.1 13.7 12.0
EV/EBITDA (x) 7.1 6.2 5.1
Compan Global Markets Research y
Post acute bundling – quick background
The PAC industry has been grappling with the potential of bundling since it was
first mentioned in Obama’s budget in Feb. 2009. If adopted widely, PAC bundling
would fundamentally change the way all PAC operated – a clear business model
risk and major valuation disadvantage (note PAC providers sold off over 30%
following the Obama budget proposal). Yet, we believe bundling could end up
being a 2-3 year demonstration/pilot project beginning in 2013 with voluntary
participation by IRFs, LTCHs and SNFs. Therefore, the more tangible impact from
reform legislation will likely be reimbursement cuts through a vehicle similar to the
AHA deal (details in attached note). One wildcard, which could ultimately help HLS
and RHB, is if a readmission policy was enacted, as it could incentivize hospitals to
discharge to higher acuity post acute providers. For reference, we include our
updated views on the IRF sector’s ability to compete for PAC patients in a bundled
environment – in the seemingly unlikely event it becomes a more important
reimbursement model.
HealthSouth(HLS) upgrading to Buy from Hold with a $16 price target
We are upgrading HLS to Buy based on: (1) We believe volumes and margin
leverage could lead to 2Q results ahead of Street expectations and mgmt could
increase 2009 guidance; (2) We believe the Ernst and Young arbitration is entering
the final phase and we are increasingly confident it will be resolved during 4Q with
a potentially material settlement figure; (3) With bundling risks mitigated, we
believe HLS could use its FCF to invest in accretive M&A not contemplated in
Street estimates. We value HLS on 8x our ’10 EV/EBITDA, a discount to historic
multiples due to concerns on health care reform.
Rehab Care (RHB) upgrading to Buy from Hold with a $28 price target
We are upgrading RHB to buy based on: (1) Continued strength in the skilled
nursing division which has been a driver of earnings upside over the past several
quarters; (2) Recent LTCH transaction shows the Hospital Division is comfortable
with the operational turnaround of the division and can expand its focus on M&A;
(3) Near-term M&A potential using RHB’s strong FCF and pristine balance sheet;
(4) Despite our new above consensus ests, we are still in-line with segment
guidance showing there could be continued upside revision. We value RHB at 6.7x
our ’10 EV/EBITDA, in-line with historic multiples.
Risks
Primary risks to HLS and RHB are unanticipated changes to health care reform,
margin pressure from labor shortages, increased competition and integration of
M&A opportunities.