Overview
ATI Physical Therapy's (ATIP) 2Q21 results were significantly worse than we anticipated, but we are not entirely ready to take it off our Position Monitor. We are dropping it to the lowest rung, and given how long it will take them to work through the problem(s), we don't expect a sudden snapback for the share price. As we explain below, we can see a path back to $7 - $8 from here.
The key problem was labor costs and losing revenue-generating therapists to competition faster than the pace of hiring, a topic we heard about several weeks ago and have been pursuing, even questioning management on it during our HedgeyeTV interview at the beginning of July. What we thought was manageable wasn't, and where we were comfortable with management, we are now suspicious. If this situation can improve, it will get better over the coming weeks as extended unemployment benefits expire, more labor supply emerges, and labor cost pressure begins to normalize. We should see this happening in the monthly BLS numbers for August and September and job board data, and we'll hear it from our industry contacts. Although, what we heard from our contacts on labor costs was nowhere near the level that struck at ATIP. The most unwelcome statement of the release, and a point that was reiterated multiple ways during the earnings call: "We expect therapist headcount to be below previously anticipated levels for 2021 which, combined with elevated costs for therapists and an unfavorable revenue mix, has caused us to reduce our forecast for 2021."
Also, the lowered guidance puts leverage out of whack again (from ~3x to back at ~6x on a net debt basis). While CFO Joe Jordan said that they are nowhere near the covenants for a more serious issue here, it creates a headwind for growth (ability to acquire, invest, etc.).
THE DOUBLE-EDGED SWORD OF STRONG VOLUME
In a quarter that saw 21,569 visits per day (+10.5% vs. 1Q21) and should have been a confirmation of our long thesis, ATIP is bleeding due to self-inflicted wounds on the staffing side from decisions made in 2020. Cutting staff, comp and benefits, perks, and whatever else management did, or didn't do, apparently made for a target-rich poaching environment that couldn't be handled in a way that didn't wreck the guide. It is not normal to see this kind of attrition with industry leaders, period. Despite hiring at a record pace and "making it right," [adding back] operational support specialists, etc. Labeed said that the problem continued into 3Q21. We would use any strength to manage risk here knowing that the near-term targets are much lower ($7 - $8 on EV/Sales) and EV/EBITDA providing a "floor" in the $4-$5 range, provided there are no further unwelcomed surprises.
Also, there may no longer be a defensible path to $30+ within our investment horizon, which is why we are moving ATIP to the bottom of the Best Ideas list. Given our process and the magnitude of the problem(s) here, the clock is starting and we'll monitor ATIP for 3 months from here to see if the data and fundamentals warrant a move up, down, or off of our Position Monitor.
No Mention of ATI First, MAJOR ISSUES WITH LABOR
With the benefit of hindsight, mistakes and risks are always more obvious. Could we have weighted that one comment or data point more heavily? Should we have updated this or that more quickly? With ATIP, did we weigh ATI First too heavily? Management called out 6 ATI First wins to start the year, but there was no mention of it today. That's a big part of our thesis and we're left with no detail to build on.
Regarding labor, when we interviewed ATIP on July 7, we asked about labor trends, a topic we had been hearing about from other operators across the industry. We anticipated both the potential impact to margins and the risk to revenue if ATIP didn’t chase therapist wages. What we heard from them sounded like a real but manageable risk, not something that could result in a 40% decline in EBITDA forecasts.
If you want to see their answer to our labor question, it can be found HERE at the 21:40 mark.
The question and answer is paraphrased here --> On the labor side, the story of wage inflation nationally is a big deal, and for health care, it's the nasty variety. Could relationships in the practices be disrupted if people come in "off-scale" and can you touch on whether ATIP has an advantage [in hiring]?
- Labeed Diab: The labor market is really interesting right now. COVID-19 has had an impact in and out of health care. We have PTs and non-PTs (ancillary roles = technicians, PT assistants, and we added an operational support specialist or OSS (an hourly role)), so we're competing with everyone and with unemployment benefits. Some of that is coming to an end, but there's a risk that they extend from Sept -> December. States are fighting that, but if you annualize some of the benefits, Washington, for example, you can make over $70k on unemployment ($56k - $57k in Illinois). For PT hiring, we've always talked about differentiators and our ability to attract and retain PTs. Our EMR is custom-built for PT (7-8 years of data, >2.5MM unique cases), which is really important when we bring on a physical therapist.
- We keep PTs away from billing and other risks and allow them to practice at the top of the license. There's no guessing about treatment plans/protocols and we have superior outcomes – back, shoulder, knee, etc., we outperform the competition when it comes to function and mobility. That said, we are seeing some erratic behavior – some regional and mid-size players are trying to poach therapists at 30%+ above normal pay, and we're dealing w/ those issues on a 1x1 basis – it's a very unique time.
Guidance Update
- Revenue $640M-$670M vs prior guidance $731M and FactSet $706.2M [5 est, $684.0-730.5M]
- Adjusted EBITDA $60M-$70M vs prior guidance $119M and FactSet $103.3M [5 est, $89.0-118.8M]
- The revised expectations reflect the impact of the following developments which are partially offset by continued strong demand for ATI's services:
- The acceleration of attrition in Q2 and continuing into Q3 caused, in part, by changes made during the COVID-19 pandemic related to compensation, staffing levels and support for clinicians. ATI has taken swift actions to offset those changes, but the company expects the impact of attrition in the second and Q3s will impact overall profitability for the year.
- Labor market dynamics that increased competition for the available physical therapy providers in the workforce, creating wage inflation and elevated employee attrition at ATI, negatively affecting our ability to capitalize on continued customer demand.
- Decrease in rate per visit primarily driven by continuing less favorable payor and state mix when compared to pre-pandemic profile, with general shift from workers compensation and auto personal injury to commercial and government, and further impacted by mix-shift out of higher reimbursement states.
Valuation
ATIP is likely to trade in a range of $3.00 - $5.00 assuming 6-10X EV/EBITDA, but given the labor pressures likely begin easing 2H21, we think ~2X EV/Sales becomes a better metric and can support a price in the $7.00 - $8.00 range.
All data available upon request. Please reach out to with any inquiries.
Thomas Tobin
Managing Director
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