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Select Medical Holdings

SEM

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Leveraging the strength of its franchise, Select Medical Holdings Corporation (SEM - Snapshot Report) delivered a 29.2% earnings surprise in the second quarter and raised its guidance for 2012. This marks the sixth straight quarter with a positive earnings surprise for this specialty hospital chain.

The favorable results led to strong estimate revisions, which helped SEM achieve a Zacks #1 Rank (Strong Buy) on August 9, 2012. With a price-to-book (P/B) multiple of just 1.64 and a price-to-sales (P/S) ratio as low as 0.51, this stock offers a promising value proposition for investors.

Strong Second Quarter

On June 30, Select Medical reported a 268.4% year-over-year surge in its second quarter net income to $43.2 million. Its adjusted earnings per share of 31 cents beat the Zacks Consensus Estimate by 29.2% and the year-ago earnings by 55%.

Net operating revenues moved up 7.4% year over year to $750.2 million, beating the Zacks Consensus Estimate by 2.9%. While revenues from the smaller Outpatient Rehabilitation segment moved up 8.2% to $193.1 million (25.7% of revenues), revenues for Specialty Hospitals rose 7.1% to $557.1 million (74.3% of revenues).

Company-wide adjusted EBITDA moved up 10.4% to $110.3 million in the reported quarter. At the segment level, adjusted EBITDA margin for Specialty Hospitals improved somewhat to 18.3% from 17.5% a year ago, while that of Outpatient Rehabilitation declined slightly to 13.4% from 13.7%.

The company continued to have substantial long-term debt (excluding current portion) of about $1.34 billion, down slightly on a quarter-over-quarter basis.

Improved Guidance

Select Medical raised its 2012 forecast for earnings per share to between $1.01 and $1.06 (earlier 86 cents and 94 cents). Consolidated revenues are expected in the neighborhood of $2.90 billion to $2.98 billion (earlier $2.85 billion to $2.95 billion).

Earnings Estimates Gain Ground

All seven estimates have been revised higher for 2012 in the last 30 days, which has propelled the Zacks Consensus Estimate by 10.5% to $1.05. This represents earnings growth of 25.0%.

Five of seven estimates have been revised higher for 2013 over the same time frame, boosting the Zacks Consensus Estimate by 6.2% to $1.03.

Favorable Valuation

Although shares plummeted last autumn, they have since recovered to current levels. In addition to low P/B and P/S multiples, the stock is currently trading at a forward P/E multiple of 9.95. Going by the usual indicators of a P/E multiple below 15.0, a P/B ratio under 3 and a P/S ratio less than 1.0 for a value stock, Select Medical appears to be undervalued.

The PEG ratio for the stock is 0.85, based on a 3- to 5- year earnings per share growth rate of 11.7%. This metric is at a 15% discount to the generally accepted yardstick of 1.0 for a fairly valued stock. It implies favorable growth potential as well.

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 956 locations.

Select Medical has a market capitalization of about $1.48 billion. Among others, the company competes with HEALTHSOUTH Corp. (HLS) in certain niches.

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