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Addus HomeCare Corp: Maintaining Growth Momentum
Target Price : $37.78
Closing Price : $32.55
Upside (Downside) Potential : +16.1%
Addus HomeCare Corporation provides a broad range of social and medical services in the home. The company’s services include personal care and assistance with activities of daily living, skilled nursing and rehabilitative therapies, and adult day care. Addus consumers are individuals with special needs who are at risk of hospitalization and institutionalization.
Market Cap : $378,4 M
Shares Outstanding : 11.3 M
52 Weeks Range : $ 29.65 – 40.75
YTD Performance : -8.9%
3Q17 Result: In-line with Expectation
Addus HomeCare posted a satisfying performance in 3Q17 with revenue and net income growth of 5.6% and 132.6% in the first nine months of 2017. We believe that Addus will continue to maintain strong performance in the future due to (1) stable and increasing growth in population over 65 in the United States; (2) Addus’ IT system in recording and managing service payment that is preferred by MCOs; (3) Addus’ financial capacity and ability to execute strategic acquisition. Therefore, we recommend OUTPERFORM with target price of $35.65, reflecting PER FY18 of 17.8x.
Revenue growth and margin improvement. Revenue growth is mainly driven by the increased in revenue per billable hour by 2.4% and 3.1% increase in billable hours. Gross margin improved by 1% due to lower direct service costs and the sale of adult day services centers that depressed the margin in the past. SG&A as a percentage of revenue decreased by 1.9% due to decrease in severance and restructuring costs.
Higher provision but lower DSO. Provision for doubtful accounts/net revenue increased by 0.3% as receivable aged over 365 days increased to 12.3% of total receivable, almost double the amount at December 2016. This is mainly due to the shift in receivable aging from Illinois governmental based program. Total receivable increased 16.6% compared to December 2016, this is much faster than the revenue growth, suggesting the difficulty in collecting payment. However, the Days of Sales Outstanding decreased by 39 days to 82 days compared to Q2 2017 due to the payment from Illinois State. We expect Addus’ DSO will improve in the future, supported by the management decision to focus on growing markets in states that has well managed fiscal budget.
Payor Mix. Illinois Department on Aging continues to be a major payor of the company, comprising 36.6% of total net service revenue compared to 43.6% in 9M16. The transition toward MCO increase the company MCO payor mix to 32.5%, a rise of 8.1% compared to the same period last year. We expect this trend to continue with MCO dominating the payor mix of Addus by 2021.
We like Addus’ stable positive revenue growth trend albeit the slowdown in growth. We think management target of 3-5% organic growth per year is attainable considering the expectation of faster growth rate in population over 65 years in U.S. Historically, between 2010 and 2016 the population aged over 65 years in U.S. increase by 2.48% per year. By 2030, Illinois is expected to experience a 76% gain (648.000 residence) in population aged 65-74 and 80% gain (418.800 residence) in population aged 75-84. It implied a projected growth of 3.84% per year for the next 13 years. We expect Addus to be able to grow in-line, if not above, the industry trend due to its leading position and experience in working with state government and MCOs, especially in Illinois.
New emerging threat to Addus business comes from the increased in minimum wage caused by wage-parity law in New York which involved the consumer-directed caregiver labor cost, causing several MCO to exit the business and is detrimental to Addus’ billable hours amount.
Addus is in a good position for further acquisition with low leverage level and consolidation trend in the industry due to the increased regulatory pressure in transition to MCOs. Investment in the Interactive Voice Response (IVR) technology allows Addus to record the services given and transfer payments to employee more effectively, which is a competitive advantage for Addus to become the preferred choice for MCOs. Complete implementation of the IVR technology is expected to also reduce the bad receivable caused by lack of service documentation.
From the management earning call, we believe Addus is capable to continue executing small acquisition target with around $10 million of revenue each year to support its top line growth. On the operational side, Addus’ liquidity position improved markedly due to the reimbursement by Illinois State, but is still exposed to future reimbursement risk. With unpredictable liquidity position caused by uncertain timing of payment by the states, management stays conservative with minimal leverage and a healthy cash balance. This condition also allows Addus to take on more leverage when presented with attractive acquisition opportunities.
We value Addus HomeCare using FCFF method with WACC of 8.7% and 2.5% terminal growth rate. We recommend OUTPERFORM for Addus HomeCare with TP $37.78, implying +16.1% upside potential from Friday’s closing price. Our target price implies PER FY18 18.9x and PER FY19 18.2 or EV/EBITDA FY18 12.4x and EV/EBITDA FY19 12.6x. This is in-line with the median EV/EBITDA of its comps but is lower than the median PER FY18 and FY19 of 25.1x and 22.1x. We remain cautious in our valuation but we believe that Addus has a huge upside potential should it be successful in reducing its operational cost, doing strategic M&A and managing its receivable with state government and MCOs.