LHC Headed for Sick Ward

Some say Medicare changes will hammer the home health company.
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Due to potential Medicare cuts, home health care chains could start landing in the sick ward as early as next year.

Chains including


(LHCG) - Get Report



(AMED) - Get Report




have found themselves operating under a cloud of uncertainty due to sweeping reimbursement changes proposed by the Centers for Medicare and Medicaid Services. And those changes, if implemented as planned in January, could prove far worse than some people imagine and ultimately shake up the entire industry.

"There is no guarantee that any of these companies can mitigate the changes successfully," warns Sheryl Skolnick, senior vice president of CRT Capital Group. And "if the companies don't mitigate successfully, the cuts to the most profitable segment of their home health business becomes the crucial element of any investment decision and analysis going forward."

So far, many experts have focused on CMS' broad proposal while waiting for more specific details. On the surface, the proposal looks relatively manageable, promising a slight increase in home health care payments overall.

But CMS plans to slash payments for those cases that currently rank as the industry's most profitable. Right now, Skolnick calculates, companies collect about $2,500 for making nine home health care calls -- a figure that jumps to $4,500 following the 10th visit.

Under the proposed changes, Skolnick estimates, that juicy bonus payment could shrink by nearly 65%.

"This is the largest single-dollar reduction in profitability imposed by the new rule," she stresses. "And it is on the class of episodes that is most frequently delivered by all home health providers under review."

Skolnick says some companies will suffer more than others. She points to LHC and Amedisys as particularly vulnerable. She launched coverage of both companies with sell ratings this week. Her firm has no banking ties to any players in the sector.

Skolnick believes that LHC relies on those highly profitable 10th visits more than any other company in the group.

"LHCG is the only company with only one 'peak' in the distribution, i.e., at the crucial 10-therapy-visit threshold," she notes. "In order for LHCG to offset the impact of the proposed rule, we believe that the company would have to substantially change its patient mix and/or, if such a change is not possible, significantly increase its volumes while maintaining mix. As physicians usually determine the number of rehab visits and must sign the plan of care, it may not be possible -- and certainly highly unlikely in the short term -- for LHCG to mitigate the impact of the proposed rule."

Skolnick fears that LHC's stock could slide to $20 a share as a result. The stock peaked above $33 this spring, shortly before CMS issued its proposal, but has fallen to $27.63 since that time.

In contrast, Avondale Partners analyst Derrick Dagnan remains decidedly bullish on LHC. Dagnan portrays LHC's home-care operating metrics as "stellar" and -- despite the company's huge exposure to Medicare reimbursements -- sees favorable trends ahead.

Dagnan has a market-outperform rating and a $33 price target on LHC's stock. His firm makes a market in the company's securities.

"The proposed

CMS rule adds several levels of complexity to the current home health Medicare payment system," he admits. "And at this time, it is difficult for operators to assess the potential impact.

But we continue to believe that large chains have the ability to appropriately adjust operations in the long term."

Meanwhile, CIBC World Markets analyst Michael Wiederhorn feels that one prominent home health care chain could actually benefit from the shakeup. Specifically, Wiederhorn indicates that Amedisys -- known for its acquisitive strategy -- could fare well in such an environment.

"We have estimated that, with $107 million in unrestricted cash and little debt on its balance sheet, Amedisys could add roughly 38 cents to our 2008 earnings-per-share estimate of $2.42

through acquisitions -- which we would expect to, at the very least, offset any reimbursement cuts," writes Wiederhorn, whose firm has investment banking ties to the company. "With the smaller players expected to struggle to adapt to the new reimbursement system, Amedisys' clean balance sheet will be a big competitive advantage in the coming quarters. As a result, we reiterate our sector-outperformer rating and $41 price target" on the company's stock.

Shares of Amedisys dropped 1.3% to $35.89 on Wednesday but remain very near their record high.

Skolnick, for one, sees no room left for upside. Indeed, she believes that Amedisys could fall to $30 a share over the next 12 months and has a sell recommendation on the stock in anticipation of that decline.

Skolnick feels a bit more comfortable about industry giant Gentiva. For starters, she says, Gentiva generates "a significant amount of revenue from non-Medicare sources" and therefore looks far less exposed than some of its peers. Moreover, she notes, Gentiva's treatment pattern features a second peak -- covering five to seven visits -- that is due for a payment increase.

Skolnick, therefore, believes that Gentiva looks best positioned to weather the Medicare storm. She currently has a fair-value rating on the company's stock but foresees a buying opportunity if the shares happen to fall hard. The stock slipped less than 1% to $19.79 on Wednesday.

Wiederhorn has taken a similar stand. He has a sector-perform rating on Gentiva's stock, which he values at $21 a share, and highlights proposed Medicare changes as the biggest threat to the name. His firm makes a market in the company's securities.

"While CMS estimates that the overall proposal is a positive 1%, there is no telling what the impact will be on individual providers given the various moving parts," Wiederhorn writes. Thus, "this issue remains the biggest near-term risk to this sector."