Odyssey Healthcare Inc
This last point is an important one to understand, as it represents a significant event risk. Medicare is the federal health insurance program for people aged 65 and over. Under the program's hospice benefit, Medicare covers nearly all services provided by Odyssey. The rates the program will pay are updated annually, and historically have increased in the 4-5% range each year. Additionally, Medicare has a cap on the amount it pays per beneficiary. Without getting into too much detail, Medicare pays for about 160 days of patient care, and any payments exceeding this must be returned by Odyssey. Historically, these chargebacks have been minor, representing 1-2% of sales in any given year. However, adverse changes to Medicare reimbursement or coverage policies would have a major effect on Odyssey and its competitors. With healthcare costs in the radar of the federal government, it is something to be concerned about, however unlikely the risk may be.
Aside from this, hospice care is clearly a growth market. The industry has more than tripled in the past 10 years, to over$10 billion dollars. There is plenty of continued expansion potential. Less than 20% of deaths received hospice care, and expanded awareness has been a big part of the market's growth. The demographics of the United States, with a huge "baby boom" population beginning to enter Medicare age, will inevitably grow demand for hospice care. For Odyssey (and its competitors), growth beyond Medicare hikes will come from consolidating this very fragmented market. One step towards this was the 2008 purchase of VistaCare, which has increased Odyssey's business by nearly 50%. With the debt from that purchase being paid down rapidly, expect more acquisition activity in the near future. With organic growth, Medicare increases, and acquisitions, there is no reason this company cannot grow at 10-15% rates annually for the next several years.
Speaking of the debt, Odyssey carries about $115 million, of which $39 million is current. This is offset by about $129 million in cash and annual free cash flow of about $76 million. Given this, and a comfortable interest coverage ratio of 12 times, I don't believe financial health is an issue here. 2009 was an outstanding year for cost control - operating margins came in at an impressive 10.5%, vs. a historical level closer to 7%.
My biggest concern here is competitive forces. There are no shortage of established and new for-profit competitors vying for a piece of this growing pie. In MFI alone, Odyssey faces competition from Amedisys (AMED) and the Vitas portion of Chemed (CHE). Most competitors are small to medium sized concerns. Around 70% of the organizations involved in hospice care are non-profits. There are very few barriers to entry, and no long-term competitive advantages like switching costs, regulatory protections, or unique assets. New providers can and do spring up weekly. Intense competition exists amongst the larger firms looking to consolidate smaller providers, driving up prices. Overpayment for growth is probably the biggest risk to shareholders, and this is one thing that MFI does not account for. When you add back in past acquisitions and calculate traditional return on capital for Odyssey, the result is a decent but not spectacular 16%.
All-in-all, Odyssey Healthcare looks like a decent Magic Formula purchase at current prices in the mid-$17 range. Trailing earnings yield is 11.8% and against projected 2010 results it is a very respectable 13.3%. Concerns about overpaying for growth and a hyper-competitive environment prevent me from considering Odyssey for the Top Buys portfolio, but MFI investors could do much worse than this one.
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Steve does not own ODSY.
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