Skilled Healthcare: Achy breaky head
Providing skilled nursing care for elderly people is all about compassion, but the business of it is mean-hearted. That makes it tough on Skilled Healthcare Group Inc. (NYSE: SKH), who, try as it might, has an industrial-strength headache that will be hard to shake.
While not as dismaying as the aging process itself, the late-life care industry is a dumbfounding maze of government programs, bureaucracies, regulations, licenses, litigation, labor shortages and costs, costs and more costs. There are enough risks in Skilled Healthcare’s annual report to be listed alphabetically. The scariest are under “M” — Medicare, Medicaid, and Medi-Cal, California’s Medicaid program.
The president’s proposed 2009 budget seeks to reduce spending on Medicare by $183 billion over five years. The budget, sent to Congress in February, would freeze payments to skilled nursing facilities and reduce payments to these facilities by $17 billion over five years.
That’s bad news for Skilled Healthcare: Medicare generated 37% of its 2007 revenues, and Medicaid supplied 31%. Medicare has often been revised, offering no firm footing for revenues in the future. “Limits on reimbursement rates or the scope of services being reimbursed could have a material adverse effect on our revenues, financial condition and results of operations,” the company said in its 2007 annual report issued in late February.
Skilled Healthcare also expects continuing cost containment pressures on Medicaid outlays for skilled nursing facilities, both in the states in which it operates and by the federal government. The cuts may be direct decreases in reimbursement rates or in rule changes that limit the beneficiaries, services or providers eligible to receive benefits.
Still the budget proposal’s cry for reductions seems difficult to achieve, say some analysts, noting a lack of urgency in Washington for cutting Medicare dollars. That may be true, but budget deficits and severe recessionary forces add an uncertainty that investors just don’t need.
Then there’s Skilled Healthcare’s vulnerability in California. A fiscal state of emergency was declared by the governor in January to deal with the state’s budget deficit. Cuts in many areas are expected, including Medi-Cal. “Any decrease in California’s Medi-Cal spending could adversely affect our financial condition and results of operation,” Skilled Healthcare says. Sit down: California gave the company 49% of revenues in 2007.
Under “L” are labor and litigation costs. Labor, which accounted for 67% of operating expenses in 2007, is a very tight market. The shortage makes it imperative that Skilled Healthcare offer competitive salaries and benefits to retain nursing staff, which reduces costs of overtime and temporary nursing agency services. Labor will be another ongoing battle for the company.
And the litigation trend in the long-term care industry is increasing, in both number and severity. Skilled Healthcare cites a report from AON Risk Consultants that says the average cost per bed for professional liability and general liability more than quadrupled to $1,610 in 2006, from $350 in 1995. The company’s long-term care operation’s liabilities were $1,576 per bed in 2007, compared to average revenue of $77,911, as it raised bed costs to pay for its risks.
Skilled Healthcare owns or leases 74 skilled nursing and 13 assisted living facilities; it has a total of 10,100 beds. Facilities are in California, Texas, Kansas, Missouri, Nevada and New Mexico; they center on urban areas and suburbs. In fiscal 2007 through December, 85% of revenue came from nursing facilities and integrated rehabilitation therapy services. The company, which offers hospice services, focuses on people who need high-level care and extensive rehabilitation, or “high acuity” patients.
The company emerged from Chapter 11 reorganization in 2003 and went public in May of 2007 at $15.50 per share. Shares ended Tuesday at $11.62 after setting a new 52-week low at $10.65. Foothill Ranch, Calif.-based Skilled Healthcare has a market capitalization of $429 million.
Discouragements aside, there is good news: Skilled Healthcare said in February that it expects 2008 earnings to rise 31% to $0.95 to $1 per share, from $0.74 in 2007. Revenues are seen at $730 million to $740 million, up 16%. Indeed, 2007 sales were up 19% year-over-year.
Bear Stearns analyst Jason Gurda says the long-term fundamentals in the nursing home sector are strong. “SKH is accelerating its roll-out of Express Recovery rehab units to take advantage of continued strong demand,” he said in a research note on Feb. 12, just after fiscal 2007 results were released. He expects SKH to use acquisitions and pay-down of high interest debt to drive a longer-term earning per share growth rate of 15% to 20%.
Gurda notes the budgetary risk to Medicare but says it is manageable as the Democratically-controlled Congress will delay major Medicare legislation until there is a new president. He carries an “outperform” rating on Skilled Healthcare with a price target at the end of 2008 at $18 — in line with the average goal of seven analysts covering the company. He looks for 2008 earnings per share at $0.96 and 2009 at $1.11.
Nobody gets out alive, or, in Skilled Healthcare’s (SKH) case, unscathed. The company just may reach $18 this year, but it will take an awfully hard head to break through those industry walls.
