This week’s bond review looks at Kindred Healthcare, a healthcare company that recently announced its exit from skilled nursing facilities in order to focus more heavily on its core service of home healthcare and strategically diversify its revenue sources.
Kindred at Home, the company’s home healthcare segment is already the nation’s largest home health, hospice and community care provider.
Kindred has routinely increased its adjusted EBITDA margins, from 5.2% in 2010 to 8.4% in 2016.
For the nine months ending September 30, 2016, Kindred had interest coverage of 2.4x.
The company has shown solid revenue growth, with its hospital rehabilitation services segment posting strong year-over-year revenue growth in Q3 of 13.1%.
Kindred has outstanding liquidity of $879.4 million.
Kindred Healthcare’s 2020 bond, couponed at 8% and currently priced about 97, is indicating a yield to maturity of over 9.5%, while its 2023 bond, couponed at 8.75% and priced about 90, is indicating a yield to maturity of about 11.2%. For investors wanting to increase portfolio diversification, adding investments in the healthcare sector can be a wise choice as healthcare is generally less volatile than other industries such as commodities, real estate, or technology. While these high 9½% and nearly 11¼% yields may be lower than some of the other more recently reviewed bond issues on the Bond-Yields.com site, they offer great cash flow and are many multiples higher that the current US Treasury yields. Therefore, we are targeting these short and medium length bonds from Kindred Healthcare for addition to both our FX1 and FX2 high yield global income portfolios.
Growth in the Home Health Care Market
One of Kindred’s business segments, Kindred at Home, is the nation’s largest and most geographically diversified home health, hospice and community care provider. Kindred at Home offers a variety of services to patients and clients in their homes or places of residence. Its home care services range from non-medical personal assistance to skilled nursing and rehabilitation, and its hospice and palliative care services provide patients with pain management and psychosocial support through chronic and terminal illnesses. Moving forward, Kindred expects that half of its earnings will come from its Kindred at Home segment, 25% from its Long-Term Acute care segment and the balance from its Rehabilitation Services segment. The following chart, from a recent presentation at UBS, shows Kindred’s changing revenue mix.
A recent report on the home health care industry forecasts the industry to be valued at $257.33 billion by 2021. In 2016, the global home healthcare market is estimated to be worth $170 billion. Impressively, the market is projected to grow at a steady compound annual growth rate of 8.5%, due in large part to a growing aging population. The rising geriatric population, the increasing instances of chronic diseases along with rising demands for various inexpensive healthcare systems are major driving factors in the growth of the home healthcare market. As Baby Boomers will continue to transition into retirement until roughly 2030, this projected growth may only be the beginning.
Kindred has recently announced that it is exiting the skilled nursing facility business, so the company can more effectively focus on its core business of home healthcare. This move is anticipated to save the company $90 million annually in rent obligations, $30 million in annual capital expenditures as well as $70 million to $100 million of annual overhead expense, for a total savings up to $220 million. Not only will this provide significant operating savings, it will allow Kindred to focus on its Kindred at Home business segment.
About the Issuer
Kindred Healthcare, Inc., a top-90 private employer in the United States, is a FORTUNE 500 healthcare services company based in Louisville, Kentucky with annual revenues of approximately $7.2 billion. As of October 1, 2016, Kindred through its subsidiaries had approximately 102,200 employees providing healthcare services in 2,702 locations in 46 states, including 82 LTAC hospitals, 19 inpatient rehabilitation hospitals, 91 nursing centers, 19 sub-acute units, 647 Kindred at Home home health, hospice and non-medical home care sites of service, 104 inpatient rehabilitation units (hospital-based) and contract rehabilitation service businesses which served 1,740 non-affiliated sites of service. Ranked as one of Fortune magazine’s Most Admired Healthcare Companies for seven years, Kindred’s mission is to promote healing, provide hope, preserve dignity and produce value for each patient, resident, family member, customer, employee and shareholder we serve.
Steady Margin Growth
Kindred Healthcare has shown steady margin growth since 2010. In 2010, the company’s adjusted EBITDA margin was 5.2%. As of March 31, 2016, the company’s adjusted EBITDA margin for the previous twelve months had grown to 8.4%. (source: Kindred Healthcare UBS presentation)
At first glance, Kindred’s most recent financials show a loss for quarterly loss in operating income of $389.5 million. However, a deeper look at the numbers reveal that much of that loss was due to a non-cash impairment charge of $324.3 million. When factoring in this and other non-cash items as well as one-time expense items, Kindred recorded Q3 operating income of $116.5 million and interest expense of $59.9 million for an interest coverage ratio of 1.9x. Similarly, calculating operating income following the same method for the nine months ending September 30, 2016 gives an operating income of $423.6 million and interest expense of $175.4 million for an interest coverage ratio of 2.4x. Not only does this represent solid interest coverage, bondholders should also note that Kindred continues to pay dividends to its shareholders, most recently a declared dividend of $0.12 per common share, which it has paid in each quarter for the past few years. Dividends represent an additional source of cash with which to pay bondholder interest in the event of a financially challenging quarter.
Kindred’s total revenues have registered impressive increases over the past few years. In 2013, the company had total revenues of $4.8 billion. Its last annual report for 2015 showed total revenues at $7.1 billion, an astounding increase of nearly 48%. For the nine months ending September 30, 2016, Kindred still registered a small year-over-year revenue increase of nearly 4%.
As the company continues to transition its revenue sources to focus more on its core service of home health care, in the near term (2016 and 2017) it is anticipating generating approximately $300 million per year in core operating cash flows, with approximately half of that amount ($150 million) in core free cash flows.
Kindred also has ample liquidity to smooth out any unexpected decreases in revenues. As of September 30, 2016, the company had total liquidity of $879.4 million. This was comprised of $139.4 million in cash and $740 million available on the company’s credit revolver.
The default risk is Kindred Healthcare’s ability to perform. The company has efficiently transitioned to a more diverse revenue model over the past few years, and in the process, has increased revenues and margins. The company’s Kindred at Home segment is the nation’s largest home health provider and is continuing to grow, most recently from the acquisition in Q3 of a home health/ hospice business in Arkansas. In addition, Kindred still has ample cash flow to pay dividends to its stockholders, which signals an extra cash cushion in the event of a financially challenging quarter. With an aging population, home health care demand is projected to continue to increase and Kindred is perfectly positioned to profit from this growth. In consideration of these factors, it appears the higher yield indicated with these bonds outweigh the risks we can identify.
Kindred Healthcare is highly reliant on payments from the Medicare program as a source of revenue. For the past seven quarters, payments from the Medicare program have comprised between 54.6% and 57.8% of total revenues. With the ongoing changes to reimbursement of post-acute care services from the Medicare system, this could have the potential to impact Medicare payments to Kindred’s providers and facilities.
With the recent elections and the pending inauguration of a new ruling party, there may be changes in the Medicare laws or other healthcare legislation that may affect how payments for care are made to healthcare providers. This in turn could affect Kindred’s revenue streams moving forward.
Summary and Conclusion
America’s largest generation, the Baby Boomer generation, is aging and moving into retirement. With aging comes increased need for healthcare. Baby boomer healthcare consumers not only need care, but also care that is affordable. Kindred Healthcare’s decision to focus on home healthcare is brilliant when considering the projected growth over the next five to ten years in this country. From an investor’s perspective, Kindred provides excellent portfolio diversification in an industry that is not generally prone to wild swings like commodities, technology, or retail. Quality healthcare is a hallmark of a developed economy. Therefore, we think Kindred’s 36 and 72 month bonds, offering yields of about 9.5% or 11.2%, will make a sound addition to both our Fixed-Income1.com and Fixed-Income2.com global high-yield income portfolios.
Issuer: Kindred Healthcare Inc.
Ratings: B3 / B-
Yield to Maturity: ~9.58%
Ratings: B3 / B-
Yield to Maturity: ~11.2%
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Disclosure: Durig Capital and certain clients may have positions in Kindred Healthcare 2020 or 2023 bonds.
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