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Encompass Health's (EHC) Growth View Makes It a Good Buy

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Encompass Health Corporation (EHC - Free Report) , the provider of inpatient rehabilitation services, is poised to grow on the back of an ageing population and its long-term strategies.

The stock has a Zacks Rank #1 (Strong Buy) at present and a VGM Score B. Here V stands for Value, G for Growth and M for Momentum with the score being a weighted combination of all three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM Score.

The combination of a solid Zacks Rank and an impressive VGM Score shows that it can outperform other stocks.

Analysts also seem to be optimistic about the company, backed by their estimate revision for 2021 earnings and revenues. The Zacks Consensus Estimate for current-year and 2022 earnings has been revised 5% and 3.1% upward, respectively, over the past 30 days.

Let’s discuss the factors favoring the stock.

Encompass Health is the largest owner and operator of inpatient rehabilitation facilities, the 4th largest provider of Medicare-certified skilled home health services and one of the top eight providers of hospice services. The sheer size of its vast business gives it an edge to serve and gain from the ageing U.S population.

Most patients served are aged 65 and older, and the number of Medicare enrollees is expected to grow approximately 3% per year for the foreseeable future. More specifically, the average age of its patients is approximately 76 and the population group ranging from 75 years to 79 years is expected to grow at approximately 5% per year through 2026.

This demography presents a vast market opportunity for Encompass Health to witness growth.

Having market prospects is one thing and harnessing the same for business growth is another. Encompass Health has all the strategies in place to  grab a market share of this growing industry. Its strategy is to expand the network of inpatient rehabilitation hospitals, and home health and hospice locations to strengthen its relationships with healthcare systems, provider networks and payors to connect patient care across the healthcare continuum and deliver superior patient outcomes.

It broadly segregated its long term strategies into the following:

Capacity Expansion: The company is incurring capital expenditure to build new hospitals and add beds to the existing facilities to cater to the potential patients. Via new hospital openings from 2021 to 2024, the company expects to add more than 1,300 beds. On top of this, it expects to add 100-150 beds to the existing hospitals in each of these years.

In its home health and hospice business, the company targets $50-$100 million of acquisitions per year. This extended capacity will ensure greater market share for the company.

The inpatient rehabilitation industry remains highly fragmented, which gives the company an edge to tap this market. Other players dominating the US post-acute care market are DaVita Inc. (DVA - Free Report) , Amedisys, Inc. (AMED - Free Report) , LHC Group, Inc. (LHCG - Free Report) among others.

Operational Initiatives a Catalyst: The effectiveness of the company’s services is defined by higher discharges to communities than to skilled nursing facilities. To this end, it is making clinical collaborations that can render quality services and lead to higher discharges to communities.

It is also working with the American Heart Association/American Stroke Association to build its stroke market share. As of Dec 31, 2020, 124 of its 137 hospitals were well equipped to manage and optimize stroke care. About 655,000 people die of heart disease in the United States every year, which boils down to one in every four deaths. This provides a huge market potential for the company to tap.

Strong Capital Position: These strategic initiatives are backed by the company’s consistent free cash flow generation. In 2020, adjusted free cash flow grew 12.3%. The same is expected to see a CAGR of 5-7% from 2020 to 2025.

Recent cash flows were used to reduce debt, thereby solidifying the balance sheet. A stable cash flow generation gives certainty to dividend payments and share buybacks. The company’s dividend increased from 72 cents in 2013 to the most recent annual payment of $1.12 per share, which implies 5.7% growth per annum, on average.

Its low payout ratio and decent growth indicate that the company is reinvesting profits in its business. This should pave the way for payout hikes in the future.

Bottom Line

Encompass Health is a well-equipped company with all the growth levers in place to generate significant returns for investors. The year to date decline of 6.3% provides an attractive opportunity to accumulate the stock, which is currently attractively priced with an enterprise value by EBITDA of 11.24, lower than the industry average of 14.98. It should thus be part of one’s investment portfolio for capital appreciation as well as dividend income.

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