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Momentum

Leveraging the strength of its franchise, Select Medical Holdings Corporation (SEM - Snapshot Report) has reported a series of positive earnings surprises over the last five quarters with an average beat of 16.3%. This specialty hospital chain was upgraded to a Zacks #1 Rank (Strong Buy) on June 13, 2012.

Select Medical is up 17.4% year-to-date compared with a tepid growth for the benchmark S&P 500 of 5.7%. Given its long-term earnings growth projection of about 11.7%, the stock should be a good play for momentum seekers.

Strong First Quarter

On May 3, Select Medical reported a 23.4% year-over-year surge in its first quarter net income to $41.5 million. Earnings per share of 29 cents beat the Zacks Consensus Estimate by 16% and the year-ago earnings by 31.8%.

Net operating revenues moved up 7.3% year over year to $744 million, riding on improved performance from both segments (Specialty Hospitals and Outpatient Rehabilitation). Revenues from the smaller Outpatient Rehabilitation segment moved up 10.2% to $190.9 million (26% of revenues), while revenues for Specialty Hospitals rose 6.4% to $553 million (74% of revenues).

Company-wide adjusted EBITDA inched up 3.1% to $109.1 million. At the segment level, adjusted EBITDA margin for Specialty Hospitals dropped somewhat to 18.1% from 19.3% a year ago, while that for Outpatient Rehabilitation declined slightly to 11.8% from 12.4%.

The company continued to have substantial long-term debt (excluding current portion) of about $1.4 billion as of March 31, 2012, up 5.6% year over year.

Select Medical reiterated its guidance issued earlier on January 6, 2012. The company continues to forecast earnings per share in a band of 86 cents and 94 cents. Consolidated revenues are expected to be about $2.85 billion to $2.95 billion for 2012.

Estimates Moving Up

The Zacks Consensus Estimate for 2012 has moved up 4.4% over the last 60 days to 94 cents per share, representing year-over-year growth of 12.2%. For 2013, the Zacks Consensus Estimate has risen 3.3% to 94 cents over the same period.

Favorable Valuation

Select Medical trades at a slight discount to its peers with respect to most valuation metrics. The stock is currently trading at a forward P/E of 10.56x, a roughly 3.5% discount to the to the peer group average of 10.94x. The price-to-book of 1.63x is approximately in line with the peer group average of 1.62x. With a trailing 12 month return on equity of 15.6%, the stock beats the peer group average of 14.4% by about 8.3%.

It has a PEG ratio of 0.9, a 10% discount to the benchmark of 1 for a fairly priced stock. This implies that the long-term growth (of 11.7%) is currently priced at a discount.

Chart May Indicate Breakout

After drifting in tandem with its 50 and 200 day moving averages for several months, the stock is trading above both moving averages since late April. We believe that the stock may have penetrated resistance levels with an expectation of further upside. A solid franchise, steady guidance, a series of earnings beats and a favorable valuation make the stock worth considering.

Founded in 1996 and based in Mechanicsburg-Pennsylvania, Select Medical manages its operations through two segments, namely the Specialty Hospitals segment and the Outpatient Rehabilitation unit. The Specialty Hospitals unit comprises hospitals catering to the requirements of long-term stay acute patients and facilities intended to serve patients who need intensive medical rehab care. Eligible enrollees are usually admitted to Specialty Hospitals from acute care hospitals. Such enrollees usually have serious and complex medical conditions.

The company operates 111 long-term acute care hospitals and 12 acute medical rehabilitation hospitals in 28 states. The company also operates outpatient rehabilitation clinics at 950 locations. Among others, Select Medical competes with HEALTHSOUTH Corp. (HLS) in certain niche markets.

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