Description
VIC – New Idea Login 10/1/01
Company: Healthcare Services Group, Inc. HCSG: $7.40
Healthcare Services Group provides housekeeping, laundry and linen, food and maintenance services to 1200 long term care facilities (yeah, nursing homes!) in the continental U.S. Dan McCartney, the Chairman and CEO founded the company in 1977 when he was 25 years old and owns about 20% with his family.
The company has survived (and remained profitable during) the bankruptcy filings (and near misses) of most of its nursing home customer base. HCSG is beginning to recover from the resulting six-fold increase in its bad debt provisioning, and volatility (in the wrong direction) of other key costs such as labor, insurance and supplies, caused partially by the unusually high churn (intentional, and otherwise) in its client base. The company is by far the dominant industry player and has continued to achieve solid revenue growth from new clients and new services, especially foodservice, despite the industry turmoil, as facilities continue to outsource non-core functions. Rate relief and balance sheet restructurings are beginning to reshape the nursing home industry and should provide a more hospitable environment for HCSG. The industry barely survived PPS and is thus unlikely to be the target of government cost cutting for the foreseeable future. “Mature” Americans (hey, Gramma could be a VIC member) are expected to be among the fastest growing segments of the population.
Reported EBITDA margins have declined sharply from historical levels, but are beginning to rebound (from 4.2-4.3%) and could once again reach the levels (+7%) routinely achieved until 1999. Given the changes in the industry, the 9% margins of the mid-90’s are probably gone for good. Simply adjusting for the “excess” reserving on pre-petition claims improves margins by 90 b.p.s and adds $2.5M (+20%)to EBITDA, or $0.14 (+23%) to reported EPS. These existing pre-petition claims will be fully reserved by Q2 2002 as the company is currently booking $3M per year in addition to the reserves created in the normal course of business. If management can achieve its 7% EBITDA margin target, 2001 revenue of $280M would produce EBITDA of $19.6M, versus $12M expected and $14.5M assuming normal reserving at 0.5% of revenues. Under this perfect (no storm) scenario, EPS would be $0.95, excluding $0.06 of interest income, versus the $0.60, including the interest income, I expect in 2001. Hey, I said “IF” and “ASSUMING”.
As we each seem to have our favorite valuation methodology, I’ll just outline some of the ways I’ve looked at the company and each can choose (or add) his/her favorite.
First (it’s my write-up, so I choose the order), enterprise value of $56M is only 4.7X un-adjusted 2001E EBITDA and as importantly (to me) 5.6X EBITDA-Capex, a cash-on-cash yield of 18% for a business that has the potential for double-digit revenue growth and a margin recovery. Using adjusted (for reserves) EBITDA of $14.5M the cash-on-cash yield is 22%. Do I even dare point out that management’s 7% EBITDA target produces a cash-on-cash yield of 31% (multiples of 2.85X and 3.2X on EBITDA and EBITDA-Capex, respectively; of course the EBITDA growth from that level would probably fade to a pedestrian 10% or so, in line with revenue growth. FYI, management’s revenue growth target is +15%, although such growth has lately “gone missing”.
Second, book value is $94M or about $8.60 per share for a P/B of 87%. Book value includes about $3M of as yet unreserved pre-petition accounts/notes receivable claims and $10-15M of reserved AR and other notes receivable; so it is either slightly over or understated depending on your perspective on ultimate collections. The company has done reasonably well in recovering claims on the cases settled to date. For a full discussion of the company’s court status as a provider of “essential services” call the company because I will just embarrass myself.
Third, excluding net cash of $27M ($2.50/share), we are paying $56M ($5) for $5.9M ($0.52) of net income, P/E’s of under 10X ex the cash and 12.5X on (unadjusted) 2001E EPS of $0.60. Adjusted EPS is $0.74 (inc $0.06 interest income) and management’s target margin would produce EPS of $1.02 (inc the interest income).
Finally, free cash flow, the kind after all expenses INCLUDING depreciation and taxes and cash used for capex ($2M) and net working capital ($4.9M), should be about $2.3M or $0.21/share. The net working capital usage reflects 10% revenue growth and NWC/Revs of 20%. Ex the net cash this drops to $1.7M or $0.15/share, a 3% yield. Now you see why I left it for last. Adjusting (for reserves) and dreaming (for management) would boost the free cash yield to 6% and 11% respectively.
The company is buying back stock in 5% authorizations and appears to have been aggressive post 9-11-2001. Dan can do math.
Competitors such as Morrison and Sodexho Marriott, while primarily in the hospitality and hospital segments, have sold out at EBITDA multiples that appear to be in the 8-10X range. I just can’t go there.
52-week range is $5-$9.
Book Value is $8.60/share.
EBITDA: $12 in 2001E; Capex $2M, D&A $2.2M
Market Cap: $82M; Net Cash $27M; Options $1M (@$7.50); Enterprise Value: $56M.
Caveats:
Where to start? Management execution; Risk of additional bankruptcy filings; Inability to collect current AR; Inability to collect on pre-petition claims; Additional PPS-like reimbursement issues; Dilutive options grants (I hate that!). While not ignoring any of these risks, especially the management execution issue, I would suggest that the improving industry outlook and HCSG’s current valuation offers some comfort and substantial opportunity.
Catalysts:
Long-term care industry recovery.
End of “excess” reserving.
Earnings/margin recovery.
Continued/more aggressive buybacks.
Strategic/Financial transaction – Dan can do the math.
Catalyst
Catalysts:
Long-term care industry recovery.
End of “excess” reserving.
Earnings/margin recovery.
Continued/more aggressive buybacks.
Strategic/Financial transaction – Dan can do the math.