Sun Healthcare Group: House of the reprising sun
If the market’s recent spate of rainy days and fears of recession have made you a little pale, then a bit of sun from the health-care sector might do you some good.
Sun Healthcare Group, Inc. (Nasdaq: SUNH) has been consistently beating consensus estimates over the past year and has seen its share price climb steadily despite the overall market slowdown that began last summer. What’s more, many analysts are predicting increased revenue growth for the company and unrelenting demand for the sector’s services — come rain or recession.
Through its subsidiaries, the Irvine, Calif.-based company operates long-term as well as post-acute inpatient nursing home facilities and offers skilled nursing, rehabilitation therapy, and specialized care for mental health and Alzheimer’s patients. Sun also has a physical and occupational therapy unit and a profitable health-care staffing unit.
The $725 million company currently manages 213 facilities in 25 states and earns the lion’s share of its revenues from a stable flow of Medicare and Medicaid reimbursements. This reliance on federal reimbursements, coupled with growing demand for its services from the increasing population of seniors over 65, make it one of the more “recession-resistant” health-care business models out there, Bear Stearns analyst Jason Gurda recently told SmallCapInvestor.com.
Sun’s current revenue growth focus is on expanding margins by controlling costs and catering to newly added Medicare reimbursement categories for rehab services, which generate more money per patient day and provide higher bed turnover than the longer-term stays of Medicaid patients.
Gurda explained that the category changes were made to push reimbursed surgical rehab services out of hospitals and into lower-cost skilled nursing centers. Sun, like many of its peers (which include Skilled Healthcare Group Inc. (NYSE: SKH) and Brookdale Senior Living Inc. (NYSE: BKD), jumped at the opportunity and adapted its business by adding just such rehab bed space.
But dependence on the sometimes politically volatile Medicare system is probably also Sun’s primary risk — something that anyone who followed the nursing home industry in the late nineties might recall. In 1999, Sun, like many nursing home providers, filed for bankruptcy after budget-balancing legislation in 1997 slashed reimbursements for nursing home rehab and acute-care services that left the company with large debts and drying revenue streams.
The company’s own rehab story began when current CEO Richard Matros took the helm in 2001 and began a long period of restructuring and debt refinancing. Matros’ vision for the company was to be a more focused, downsized entity that owned, rather than rented, the bulk of its facilities.
Sun emerged from bankruptcy in 2002 and eventually sold off several non-core businesses and later purchased two other nursing home operators: Albuquerque, N.M.-based Peak Medical Corporation in 2005 and Boston-based Harborside Healthcare Corporation in 2007 with its 73 facilities in 10 states.
So far, the recent shift to a more diversified patient and geographic mix seems to be paying off. In a recent investor conference presentation, Matros said that by the end of the first quarter 2008 the Harborside deal will have created about $10 million in synergies.
Sun’s third-quarter 2007 revenues, which include Harborside’s contributions, rose an impressive 73.9% to $439.6 million from $252.8 million in the third quarter of 2006, while net income was up to $5.2 million, or $0.12 per diluted share, from a net loss of $1.2 million, or $0.04 per share. At the time of reporting, Sun also bumped up its full-year 2007 earnings per share guidance.
The results were better than expected and led to Bear Stearns upgrading Sun to “outperform” in a Nov. 8 report because higher cash flows could mean that Sun could pay down its debt and de-leverage itself even faster.
In fact, the company has said it plans to take a breather from acquisitions in 2008 and use its cash on debt reduction while focusing on organic growth and fine-tuning the business — steps that will improve fundamentals for the rebounding company and undoubtedly please investors. Specifically, Sun plans to add more profitable rehab capabilities to more of its facilities, roll out an electronic medical records process and grow its fledgling hospice business.
By and large, most other analysts are now beginning to see the light and foresee opportunities for revenue growth on the horizon driven by momentum from the Harborside deal. The average price target of the seven analysts surveyed by Thomson Financial is $18.86. Shares of Sun closed at $16.82 on Wednesday and have traded between $11.88 and $18.78 over the past year.
In a Dec. 17 report, Credit Suisse analyst Ken Weakley initiated coverage with an “outperform” rating and a $20 per share price target. He wrote that Sun could generate short-term earnings per share growth above 20% as it extracts value from existing assets and grows organically.
On Jan. 22, Stifel Nicolaus analyst Eric Gommel raised his price target to $20 from $18.00 and raised his 2007, 2008 and 2009 earnings estimates because of the increased likelihood of a Medicare market-basket rate increase and his belief that Sun’s (SUNH) shares deserve a premium valuation to its group.
Forecasts like that are about as sunny as they get in today’s stormy market. With winds at its back from the now-stabilized and increasingly favorable federal reimbursement front, a seamless merger integration, and management’s proven ability to execute and exceed expectations within tight margins, the future is looking brighter and brighter for this rising sun.
About the Author
Matt Bierce previously served as a news writer and bank and thrift sector beat reporter for SNL Financial, a niche financial data and news provider in Charlottesville, Va.
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