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Nursing Homes Industry Outlook: Multiple Challenges Ahead

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In recent years, continuing efforts of governmental and third party payors to contain the rate of payment for the provision of healthcare services has impacted the nursing home industry.

In addition to rate pressure, the industry is suffering from lower revenues from the continued shift from ‘traditional” Fee-for-Service (FFS) Medicare patients to Medicare Advantage (MA) patients. Since reimbursement rates and average lengths of stay are generally lower for services provided to MA patients than they are for the same services provided to traditional FFS Medicare patients, this trend has negatively impacted the industry’s profitability and will continue to do so.

The industry is also facing new challenges and complexities with respect to billings and collections due to the emergence of managed Medicaid programs that have resulted in lower rates of reimbursement for its services. Further, migration to managed Medicare and Medicaid is expected to continue, and bring along with it woes of the lower operating margins and profitability.

Nevertheless, as life expectancy continues to increase in the United States and seniors account for a higher proportion of the U.S. population, overall demand for the services provided by nursing facilities will increase. Thus players in the industry that render cost effective and efficient services stand to gain.  

However, providing quality care requires professional and skilled nurses, which leads to higher personnel costs. Shortage of nursing staff is also pushing up labor costs. Moreover, investments in information systems and reengineering of key business and operating processes required to improve operating efficiency should lead to higher total costs, thereby straining margins.

Industry Lags the Broader Market in Terms of Shareholder Returns

Looking at shareholder returns over the past, it appears that the pressure on top line and high operating expenses that have drained margins make investors cautious about the industry’s growth prospects. Despite an increasing senior population, revenue growth remains muted as patients move to lower-cost settings such as home healthcare.

Zacks Medical-Nursing Homes, which is a stock group within the broader Zacks Medical Sector, has underperformed the Zacks S&P 500 Composite but outperformed its own sector over the past year.

We see that the stocks in this industry have collectively gained 8.2% over the past year, while the Zacks S&P 500 Composite and Zacks Medical Sector have grown 15.9% and 3.2%, respectively.

One-Year Price Performance

Attractive Valuation

The company has underperformed its sector in the past year, and its valuation look quite attractive now. EV/EBITDA is on of the appropriate measure to value nursing home industry because of huge capital expenditure incurred in the form of building and construction of new facilities.

The industry currently has a trailing 12-month EV/EBITDA ratio of 4.22, somewhat higher than the lowest level but is at its median over the preceding year. When compared with the highest level of 5.68, there is apparently room for upside.

The space also looks inexpensive when compared with the market at large as the trailing 12-month EV/EBITDA ratio for the Zacks S&P 500 Composite is 11.92 and the median is 11.50.

EV/EBITDA Ratio (TTM)

Also, the Zacks Medical Sector’s trailing 12-month EV/EBITDA ratio of 10.96 as well as the median level of 10.33 for the same period is way above the Zacks Medical Nursing Homes Industry.

EV/EBITDA Ratio (TTM)

Underperformance Likely to Persist on Bearish Earnings View

Shifts in healthcare industry have created a tough operating environment for the nursing homes industry. Nursing homes contact insurers and managed care organization for patients. Ongoing consolidation in the health insurance space has reduced the number of players, thus thinning the supplier base for the nursing home industry. Moreover, a dearth of insurance policies that provide long-term care insurance, which pays for nursing home care, has kept patients away from nursing homes.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the above ratio analysis shows that there is a solid value-oriented path ahead, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.

One reliable measure that can help investors understand the industry’s potential for a robust price performance is the earnings anticipation for its member companies. Empirical research shows that a company’s earnings guidance significantly influences its stock performance.

The Price & Consensus chart of the industry shows the market's evolving bottom-up earnings expectations for the industry as well as its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings projections for 2019, while the light blue line represents the same for 2018.

This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Price and Consensus: Zacks Medical Nursing Home industry

 

Please note that the 74 cents loss per share estimate for the industry for 2018 is not the actual bottom-up loss per share estimate for every company within the Zacks Medical Nursing Homes  industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry’s earnings for 2018 but how this estimate has evolved recently.

The consensus loss estimate for the Zacks Medical-Nursing Homes industry of 74 cents per share implies deterioration from a loss of 47 cents per share a year ago. The trend in earnings estimate revisions has also been unfavorable.
Looking at the aggregate earnings estimate revisions, it appears that analysts’ confidence in this group’s earnings potential is dwindling.

Current Fiscal Year EPS Estimate Revisions

The consensus loss estimate for the current fiscal year has gone down to 74 cents from loss estimate of 60 cents since Jul 31, 2018.

Zacks Industry Rank Indicates Cloudy Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.

The Zacks Medical Nursing Homes industry currently carries a Zacks Industry Rank #238, which places it at the bottom 7% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry’s rank has continually deteriorated over the past five weeks.

 

Medical Nursing Homes: Earnings & Revenue Trends

Decline in patient volumes due to continued shift of patient from costly treatments at inpatient facilities to outpatient facilities such as home healthcare have created a pressure on the industry’s top-line growth.

Moreover, high labor cost and other operating costs are weighing on the industry’s bottom line.

Summing Up

Multiple headwinds on the cost and revenue fronts, will continue to plague the nursing home industry. The shift from nursing homes to home healthcare will only gather pace in the years ahead. Innovation in home-based technologies which provide a range of services (similar to that provided at nursing homes) within the confines of home, will only facilitate the shift.

Increasing difficulty in recruiting and retaining labor, is another headwind nagging the industry.

High cost of constructing the brick-and-mortar facilities amid scarcity of land entails capital expenditure and is another big constraint.

We thus caution investors to stay away from the below-mentioned stocks, each having an unfavorable Zacks Rank #4 (Sell).

(You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.)

Brookdale Senior Living Inc. (BKD - Free Report) , is a leading owner and operator of senior living facilities throughout the United States. The stock has witnessed its loss estimates move to $3.51 per share from $3.16 over the past 60 days. The stock has lost 16.2% over the past year.

Price and Consensus: BKD

Capital Senior Living Corp. (CSU - Free Report) is one of the largest providers of senior living services in the United States. The stock has witnessed its loss estimates move to $1.06 per share from loss estimate of 71 cents per share over the past 60 days. The stock has lost 28% over the past year.

Price and Consensus: CSU

Five Star Quality Care, Inc. (FVE - Free Report) is in the business of leasing and operating senior living facilities, including senior apartments, assisted living facilities, congregate communities and nursing homes. The stock has witnessed its loss estimates move to $1.14 per share from loss estimate of 50 cents per share over the past 60 days. The stock has lost 36.3% over the past year.

Price and Consensus: FVE

Despite tough operating conditions, the players having a national presence and reaping operating efficiencies can stay afloat. We thus point a stock, which is worth keeping an eye on.

The Ensign Group (ENSG - Free Report) , provides a broad spectrum of skilled nursing and assisted living services, physical, occupational and speech therapies, home health and hospice services, and other rehabilitative and healthcare services at healthcare facilities, hospice agencies, home health agencies and home care businesses.

The Zacks Consensus Estimate for current year earnings of $1.85 per share, points to a year over year growth of 34%.

The stock, carrying a Zacks Rank #3 (Hold), has gained 77.3% over the past year.

Price and Consensus: ENSG


 

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