This week, Durig Fixed Income 2 (FX2) takes a second look at a company that is redefining what home health care looks like.
Kindred Healthcare recently sold all of its skilled nursing facilities in order to focus more heavily on its core service of home healthcare. Its most recent quarterly results recorded revenue increases for two of its three business divisions. Some other highlights from its most recent results:
Kindred at Home and Kindred Rehabilitation Services increased revenues year-over-year by 3.9% and 2.2% respectively
Kindred recorded net cash from operating activities in Q2 of $92.7 million.
- Kindred at Home, the company’s home healthcare segment is already the nation’s largest home health, hospice and community care provider.
Home healthcare is a growing need as the baby boomer generation moves into their 60’s and 70’s, in fact it is forecast to grow by 6.7% annually through the year 2025. Kindred’s services in home healthcare as well as rehabilitation services are perfectly positioned to take advantage of this trend. The company’s 2023 bonds, with a current yield-to-maturity of about 9.4%, would add excellent diversification in the healthcare sector to an already diversified portfolio. In light of these developments, we will look to increase the weighting of these bonds in our Fixed-Income2 managed income portfolio. The most recent performance of our managed FX2 portfolio is shown below.
An Update Since Our Last Review
Since our last review of Kindred Healthcare in November of last year, the company has taken a giant step towards transforming its revenue sources. In our last review, we related Kindred’s intentions to exit the skilled nursing facility space by divesting its ownership in these types of facilities. In July 2017, Kindred announced the the sale of 89 skilled nursing facilities and seven assisted living facilities for $700 million in cash. This sale is the culmination of Kindred’s desire to focus on higher margin, faster growing businesses and move away from capital-intensive lines of business, such as skilled-nursing facilities, and move more towards home health services. This move will eliminate $100 million of annual lease expense for Kindred and $30 million per year in capital expenditures. After-tax net proceeds from the sale is expected to be between $100 million and $300 million after transaction costs and expenses.
Kindred is the company to watch in home healthcare. Currently, the company boasts some pretty impressive statistics in the home healthcare arena.
Kindred at Home is the number one operator of home health and hospice services.
Kindred Hospitals is the number one operator of transitional care hospitals.
- Kindred Rehabilitation Services is the number one operator of rehabilitation services
These designations have been earned in large part to Kindred’s dedication to providing outstanding post-acute care for the patients it serves. Post-acute care includes rehabilitation or palliative services that beneficiaries (patients) receive after, or in some cases instead of, a stay in an acute care hospital. This type of care is in high demand (and demand is growing) within the Medicare population.
About the Issuer
Kindred Healthcare, Inc., a top-100 private employer in the United States, is a FORTUNE 500 healthcare services company based in Louisville, Kentucky with annual revenues of approximately $6.1 billion. As of June 30, 2017, Kindred’s continuing operations, through its subsidiaries, had approximately 88,100 employees providing healthcare services in 2,540 locations in 45 states, including 81 LTAC hospitals, 19 inpatient rehabilitation hospitals, 19 sub-acute units, 614 Kindred at Home home health, hospice and non-medical home care sites of service, 102 inpatient rehabilitation units (hospital-based) and contract rehabilitation service businesses which served 1,705 non-affiliated sites of service. Ranked as one of Fortune magazine’s Most Admired Healthcare Companies for eight years now, Kindred’s mission is to promote healing, provide hope, preserve dignity and produce value for each patient, resident, family member, customer, employee and shareholder served.
Kindred Healthcare – Past and Present
Kindred has spent the past several years transforming its business from a healthcare provider in the more cost-intensive hospital space and moved towards the higher margin home healthcare provider. This is best illustrated by the following graphic from a recent Kindred investor presentation.
Home Health Care: The Next Big Wave in Healthcare Spending
The Centers for Medicare and Medicaid services (CMS) estimates that national healthcare spending will grow by an average of 5.6% between 2016 and 2025. As a result of this growth, national healthcare expenditures will make up nearly 20% of the nation’s economy. Home healthcare is anticipated to grow around 6.7%, the highest of any sector in personal healthcare. It is believed that this increase will be driven primarily by a 7.8% average increase in Medicare spending between 2020 and 2025, as millions of the Baby Boomer generation hit their 70’s and require home healthcare more often.
Interest coverage is of paramount importance to bondholders because it represents a company’s ability to service its debt. For its latest reported quarterly results, Kindred’s interest coverage is sufficient to cover its debt. With net cash from operating activities of $92.7 million and interest expense of $60.8 million, the company has interest coverage of 1.5x. With the company’s recent move away from the capital intensive skilled nursing facilities, hence reduction in overhead, interest coverage should start to increase.
Two of Kindred’s three business divisions posted increases in Q2 revenues (ending June 30, 2017). The company’s Kindred at Home Division recorded Q2 revenues that increased 3.2% over the prior year period. Also, Kindred Rehabilitation Services increased Q2 revenues year-over-year by 2.2%. The company also recorded core free cash flows in Q2 of $62.4 million.
Kindred also has ample liquidity to smooth out any unexpected decreases in revenues. As of June 30, 2017, the company had total liquidity of $873 million. This was comprised of $130 million in cash and $743 million available on the company’s credit revolver.
The default risk for bondholders is tied to Kindred Healthcare’s ability to transition after its divesting of its skilled nursing facilities. The company is slated to record annual savings on its lease expense of $100 million which will directly affect the company’s bottom line. Revenues grew in Q2 in two of its three business divisions. The company has ample cash and credit revolver credibility to smooth out any cash flow challenges during volatile quarters. 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 nearly 9 1/2% yield to maturity on these January 2023 bonds outweigh the risks identified here.
Kindred Healthcare is highly reliant on payments from the Medicare program as a source of revenue. A recent proposal from the federal government would redistribute payments away from home health services, which currently produce savings for Medicare. 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 last year’s elections and the recent discussions of healthcare reform, 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
Kindred Healthcare has successfully transitioned its business to focusing on post-acute care, which includes home healthcare. The recent sale of its skilled nursing facilities will not only provide an infusion of cash for the company, but also produce savings in its leasing / rent expense of approximately $100 million, annually. Kindred’s 2023 bonds also provide investors with 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 find Kindred’s 2023 bonds, couponed at 8.750% and with a yield to maturity of ~9.4%, have met our criteria for additional weighting in our FX2 managed portfolio.
Issuer: Kindred Healthcare Inc.
Ratings: B3 / B-
Yield to Maturity: ~9.4%
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