Care That Feels Like Home

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Feb. 19, 2008 (Investor’s Business Daily delivered by Newstex) —

Health care providers are finding there’s no place like home when it comes to treating the aging and chronically ill.

The demand for outpatient and home health services is booming, fueled by a graying population. Because aging baby boomers are living longer, the incidents of diseases such as diabetes and high blood pressure are rising. So there’s an increase in the pool of patients needing ongoing care.

At the same time, advances in technology allow patients, such as stroke victims, to convalesce in the home after hospital discharge rather than in a nursing home.

Home health care continues to be the fastest-growing component of all personal health care spending, says the Centers for Medicare & Medicaid (CMS). Year-over-year spending for free-standing home health care rose 9.9% in 2006, following a 12.3% rise in 2005.

Members of IBD’s Medical-Outpatient/Home Care industry group are reaping the benefits. As of Friday, the group ranked No. 39 out of IBD’s 197 industry segments.

The industry is driven by Medicare, which represents 66% to 95% of their business, says analyst K. Newton Juhng of BB&T (NYSE:BBT) Capital Markets.

“The biggest pressure is cost, and home health is the lowest-cost environment for Medicare,” he said.

In 2006, the cost of a day in a hospital was about 40 times the cost of a home health visit.

1. Business

Home health services include nursing care, physical therapy, personal care, oxygen treatments for patients with lung disease, and delivery of nutrition fluids and pain medications intravenously and through injections.

Companies in the group serve patients with the need for short-term and long-term care, but differ in their approach to the business.

Take LHC Group (NASDAQ:LHCG) LHCG. It offers health care services to elderly patients following a hospital stay or illness through home nursing agencies, hospices, long-term acute care hospitals and outpatient rehabilitation clinics. It has 175 locations, mainly in rural areas.

“Our focus on rural markets is a benefit because there’s less managed-care penetration in those markets, and managed-care companies are the poorest payers for home health,” said LHC Chief Executive Keith Myers.

LHC has grown fast. Over the past five years, sales climbed at an average annual rate of 45% with earnings up 61% a year.

“To a certain degree our success comes from being in the right place at the right time,” Myers said.

LHC has reaped benefits from having economies of scale when the industry began consolidating, he says.

It has been an active acquirer, closing about 20 buys a year in the past two years; in 2007 it made 25 acquisitions. In addition to buying other agencies, LHC forms joint ventures with nonprofit health organizations.

Gentiva GTIV offers comprehensive home health and related services, including nursing, occupational and speech therapies and disease management. It has more than 300 home health locations in 36 states. It’s CareCentrix operation manages home health care services for major managed care organizations throughout the U.S.

Over the past five years earnings have grown at a 30% average annual clip and sales by 10%.

Gentiva differs from other home care players by offering specialty care programs covering specific health issues, says Chief Executive Ron Malone.

Among its three programs is Gentiva Orthopedics, which brings orthopedic rehab services to patients recovering from orthopedic surgery such as joint replacement.

“These specialty programs make us distinct and apart from what you think of as a general store for home care,” he said.

In local markets where people often view home care as a commodity service, these programs help build relationships with physicians based on the specialties, the company says. They can also help get nursing referrals.

Medicare represents about 66% of its home health business.

Over the past few years, most of Gentiva’s Medicare growth has been driven by the performance of the specialty programs, he said. Another growth driver: strong retention for the caregivers participating in these programs.

Malone focuses on larger, more “meaningful” acquisitions in the $20 million to $120 million range. He looks for high quality companies that share Gentiva’s values and have similarly run services.

Overall, home health is a relatively high margin business for one that tends to be Medicare intensive, says analyst William Bonello of Wachovia (NYSE:WB) Capital Markets. Operating margins average 13% to 14%, a healthy profit for a company in the sector, he says.

It’s not a cash-intensive business; labor is the predominant cost.

Most companies in the group are good cash generators, and they spend a lot of that cash on acquisitions, he says.

Name Of The Game: The key in home health care is focusing on the local environment, says analyst Juhng.

Since health care is delivered locally, it’s important for people in the community to feel like the agency is in touch with it.

At the same time, each agency must protect its referral stream. The relationships with doctors and hospital discharge agents is important.

2. Market

About 8,500 home health agencies do business in the U.S. The market is dominated by small mom-and-pop outfits. The top three or four operators have just 10% of the market, says Juhng.

The big players — such as Amedisys AMED, LHC and Gentiva — have the opportunity to aggregate and grow via acquisitions.

“They’re all doing it now and we’re expecting them to do more in the future,” he said.

The recent cut in Medicare rates hurts the profitability of the smaller operators more than the bigger ones. The bigger operators will be able to ride out the reimbursements cuts and use the cash they generate to buy the small outfits, he says.

CMS has pegged annual spending on home health care, including hospices, at about $53 billion, says Bonello. And it’s estimated to exceed $100 billion by 2015.

A hefty 7.6 million patients receive some home health care each year, about 70% of whom are age 65 or older, says Bonello.

3. Climate

The government drives the climate for the industry, which is heavily dependent on government funding.

Medicare is the highest-margin business for home health care providers, says analyst Derrick Dagnan of Avondale Partners.

The climate for Medicare reimbursement has remained stable since 2002. That changed on Jan.1, when the new Medicare payment changes for home health care providers went into effect, increasing the complexity of the payment system.

The changes stand to reduce operators’ Medicare reimbursement revenue. The Centers for Medicare & Medicaid Services estimates that for-profit home health companies operating in rural areas will take a 5.6% hit, while those operating in urban areas will see a 1.7% drop, Dagnan says.

The first half of 2008 will be an adjustment period, he adds. Some operators may falter and have a tough time making some adjustments.

“I believe home health operators can gain a better understanding of how to operate profitability in the future,” he said. “But I don’t believe they can make those changes on day one.”

4. Technology

The industry is focused on labor productivity and tools to help with administrative jobs like billing, reviewing claims and assuring the accuracy of the coding in documentation, Dagnan says.

At Amedisys, nurses and therapists wield laptops to feed clinical information back to the company’s central data center. Doctors who subscribe to Amedisys’ system can electronically access the information through the company’s electronic portal.

This bedside technology cuts out a lot of administrative work and speeds up the transmission of data, says analyst Bonello.

5. Outlook

The industry will continue to benefit from the needs of the aging population.

About 35 million Americans were 65 or older in 2000, according to the U.S. Census Bureau. That’s expected to rise to about 40 million by 2010.

Another big plus: Home health is the lowest cost setting of care at a time when health care costs are spinning out of control, Dagnan says.

As a result home health care should be in demand in the long term.

Upside: For their part, home health care operators have the ability to find good acquisitions and continue to consolidate the industry successfully without any big integration problems, says analyst Darren Lehrich of Deutsche Bank. (NYSE:DB)

Risks: The wild card is Medicare pricing.

“If Medicare decides these guys are making too much money, it has the ability to give a huge whack to their profits,” said analyst Juhng. “But in our opinion, Medicare wants to have more volume in the lowest cost environment — and that’s home health.”

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