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We are upgrading our recommendation on Gentiva Health Services Inc. (GTIV - Analyst Report) to Outperform based on its strong revenues and strategic acquisitions. Furthermore, a reduced debt balance improved its financial leverage, while a better operating performance led to an improvement in net cash from operating activities and free cash flows.

Gentiva reported second-quarter 2012 net earnings of 35 cents per share, exceeding the Zacks Consensus Estimate of 28 cents but lower than last year's 47 cents. Net income of $10.7 million also compares unfavorably with $14 million in the year-ago quarter.

Gentiva is a leading national provider of comprehensive home health services and competes with Amedisys Inc. (AMED - Analyst Report), among others. The company’s earning ability has remained strong over the years with its net revenues increasing consistently. Based on revenues, the company is currently the largest provider of home health and hospice services in the U.S.

Moreover, Gentiva’s focus on specialty programs, targeted to aid the aging population, remains impressive. The company also undertakes strategic acquisitions to expand its scope of operations and geographic coverage. The acquisition of Advocate Hospice in July 2012 is expected to spread out Gentiva’s coverage in central and southern Indiana and leverage the company’s existing hospice and home health facilities in the state.

However, the changes proposed by the Centers for Medicare & Medicaid Services (CMS)  for Medicare Home Health Prospective Payment System payments are expected to reduce Medicare reimbursements by 0.1% in 2013, thereby reducing Gentiva’s earnings, which rely significantly on Medicare earnings. The previous Medicare reimbursement cut, proposed in October 2011, is also expected to negatively impact Gentiva’s 2012 earnings by $35 million.

Furthermore, the rising expenses of Gentiva are negating the increase in revenues, leading to reduced bottom-line growth. Rising expenses have weakened its operating cash flow over the past few years, although the company still has a considerable cash balance. Additionally, the credit agreement in March 2012 increased the interest rate on term loans, thereby substantially increasing the company’s interest expenses.

Overall, we see strong growth potential for Gentiva in the long term. The company carries a Zacks #2 Rank, which translates into a short-term Buy rating.

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