Description

Investment Summary:
Our latest contribution to the VIC home healthcare discussion – we are long shares of The Pennant Group (PNTG).  We previously wrote up PNTG as a short in 2019 when it was trading >$30/share, or around 50x FY20 EBITDA estimates at the time.  Now, at ~$20/share and ~10x consensus NTM EBITDA, we have decided to revisit the name.

In our 2019 writeup, we were critical of 1) PNTG’s higher exposure to the asset-heavy, oversupplied Senior Living segment; and 2) the significant capital lease balance sheet leverage (at the time, nearly ~5x).  Since then, mix has shifted such that 72% of total revenue came from HHH, compared to EHAB and AMED which are both ~100%, and net leverage has moderated to 4.2x EBITDAR.  

Now, post-pandemic, PNTG is positioned to benefit from secular trends of an aging senior population/shift to value/home-based care, as well as early cyclicality as senior living demand catches up to previously overbuilt supply.

Background:

There have already been several excellent VIC write-ups posted on healthcare services names, so we’ll try to stick to a high-level discussion of the industry.  Specific to home health and hospice, we would refer you to EHAB writeups from Dr. Ridgewell, gary9, and Bismarck, (as well as their relevant comment sections) to get up-to-speed.  You may also refer to our prior writeups on PNTG and EHC.

For those newer to the story, we will attempt to briefly summarize:  PNTG is a provider of home healthcare and hospice services and operates 53 senior living communities across the continental United States.  The company spun off as the OpCo from Ensign Group PropCo (ENSG) back in 2019 and was one of several  publicly traded entities in the HHH space – the others being AMED, KIND (taken out by HUM in ’17 at ~8.5x LTM EBITDA), LHCG, and EHC (later spun off EHAB).  

Today, EHAB is the only remaining publicly traded pure-play HHH operator.  Optum (UNH) scooped up LHCG for $170/share (23x FY23 EBITDA) early last year and is attempting to close on AMED for $101/share (13.5x FY24 EBITDA).  ADUS and CHE (VITAS), while public, are primarily hospice.

EHAB bulls argue that at ~11x FY24 EBITDA the company is trading at a steep discount to precedent transactions, and we agree with this sentiment.  

Our View :

Thesis 1) Home Health + Hospice benefits from secular tailwinds and is a mini-ENSG:

PNTG is a mini-Ensign Group, and we believe PNTG is employing the same playbook that turned ENSG into a quality compounder (~20% 10Y share price CAGR).  The senior care industry has faced a myriad of issues post-COVID, with the overwhelming trend being a shift from skilled nursing facilities (SNFs) toward home-based/outcome-driven care.  The pivot of healthcare toward value-based care (VBC) has been front-of-mind for nearly a decade but was accelerated by the pandemic.  The industry is under pressure from multiple angles:

• Payers: VBC under MA/managed care plans typically have tighter control over reimbursements and care delivery and therefore potentially carry lower reimbursement rates for providers.  Meanwhile, operating costs are rising due to the incremental regulatory burden of complying with quality control metrics and minimum staffing requirements.

• Labor: The critical talent shortage among healthcare professionals is well understood.  Fewer young professionals are entering the labor pool post-COVID due to perceived risks and diminished appeal, contributing to an aging workforce.

These have caused a bifurcation among providers between for-profit (often privately owned, PE-backed entities) and traditional NFP/hospital SNFs.   While for-profit SNFs have deep pockets and operational flexibility vis-à-vis regulatory changes, they have faced criticism over historical instances of prioritizing financial outcomes over quality of care.  Meanwhile, NFP entities often lack access to capital and are slower to adapt – the exception being endowment-backed models.

The keys to ENSG’s outperformance over the last decade have been its decentralized/local leadership org structure, performance-based incentivization, and shrewd capital allocation.  ENSG differentiates itself by treating local healthcare administrators as operational “CEOs.”  This model delegates key operational decision making on the local level, whereby greater transparency and accountability leads to superior patient outcomes.  Local leaders are organizationally aligned via incentive compensation that is linked to both clinical and financial outcomes.

PNTG operates under the same framework, allowing it to achieve superior KPIs vs peers.  As of 3Q23, PNTG reported an average QoPC STAR rating of 4.1 vs. national avg. 3.0 (EHAB 3.6) and a 13.1% 60-day hospitalization rate vs. national median 14.1% (EHAB reports a 14.5% 30-day readmission rate).  PNTG home health is also more heavily concentrated in MA/MCO plans compared to peers.  In 4Q23, Medicare FFS was 71% total PNTG HHH revenue (excluding home/personal care revenue) vs EHAB and AMED’s 69% and 74%, respectively.  Note, however, that PNTG carries a higher Hospice revenue mix (50%) vs EHAB (20%), which is 97% paid via Medicare FFS/Medicaid.

Most investors may not initially care for these industry-specific metrics, but PNTG has leveraged their superior results and MCO relationships to win new and more favorable contracts.  PNTG is also securing JV partnerships (previously Scripps and John Muir effective Jan 1st) as NFPs may be reluctant to work with large PE-backed or private payer-controlled entities. 

Thesis 2) Senior Living (LTM 28% revenue, 30% EBITDA): demand catching up to meet already built capacity.

PNTG is set to benefit from several years of capacity expansion ahead of a senior living upcycle.  In January, NIC reported that senior living occupancy across key markets increased 80 bps from 84.3% in 3Q23 to 85.1% in 4Q23.  This is the tenth consecutive increase in quarterly occupancy.  Similar positive occupancy trends are seen at both PNTG and BKD.  We believe that an increase in occupancy across PNTG’s current SL portfolio toward the low/mid-80s has the potential to meaningfully grow EBITDA/share, without any further capacity additions or pricing adjustments.

For example, 3,776 units (following the acquisition of 2 facilities subsequent to year-end)  x 85% capacity = 3,210 occupied units:

• $4,450* monthly rent / occupied unit, less

  • ~$3,100 monthly operating costs / occupied unit 

  • ~$770 fixed monthly rent / total units

• Returns nearly $17M SL EBITDA vs $12.3M in FY23 (+40% Y/Y to SL segment aEBITDA, or +10% to consolidated aEBITDA).

  • *Note: PNTG’s disclosed avg. SL revenue per occupied unit is $3,969 vs. our calculation of $4,450.  There may be other things baked in here, but for modeling, we are just looking at total SL revenue / occupied units / months.

Of course, this is the blue-sky scenario.  While we believe an 80% NTM occupancy target is more realistic (still an incremental +14% to segment aEBITDA and +4% consolidated), we would not be surprised if it were higher given the slowdown in construction activity/supply additions and robust demand from an aging population (see NIC MAP Vision 4Q23 Key Takeaways).

BKD, a pure-play operator of senior living communities and probably the closest comp to the PNTG SL segment, trades for 14-15x LTM $335M EBITDA (TEV ex-operating leases) and 13x fwd estimates.  BKD EBITDA grew +39% over the LTM off +11% rev growth and margin expansion 9% -> 12%.  Meanwhile, +15% rev growth and margin expansion 5% -> 8% has more than doubled PNTG’s SL EBITDA.  

At $14M fwd aEBITDA derived from an 80% occupancy rate and similar rent/operating costs, we can value the PNTG SL segment at approximately $200M (30% current TEV) using a 14x fwd multiple.

Valuation:

PNTG’s HHH business is a low/mid-teens grower (4Q23 +18% y/y) with mid/high-teens EBITDA margins (16% at 4Q23), compared to EHAB which carries higher margins (~20% HHH ex-corporate) but declined -1% in 4Q23.  Unlike EHAB, PNTG is not cheap – the current $690M TEV implies ~16x LTM HHH EBITDA (less corporate overhead) and 15x LTM SL EBITDA, compared to EHAB ~11x and BKD ~14x.

We believe that PNTG can grow into its premium multiple via HHH share gains (further SNF headwinds e.g., rate cuts should lead cost conscious payers to shift more care into the home) and SL occupancy growth, both of which are secular beneficiaries of an aging population (with early cyclicality in SL).

Catalyst

• Aging US senior population and senior living upcycle
• Secular trend toward value-based/home-based care