ACHC | Setting Up for Our Shot
Background
When we began our work on Acadia Healthcare (ACHC) in 4Q21 we recognized signs of severe labor tightness in mental health resulting in spiking wages and limiting patient volume, especially for legacy providers. With limited pricing levers to pull, traditional mental health entities appeared to be disadvantaged both at an administrative level and in attracting providers to a hostile working environment. We initiated our short expecting the company to choose between deferring growth or lower margins.
We outlined a scenario where management would either spend more on SWB in order to adhere to previously outlined facility openings, or delay openings in order to preserve historical SWB margins during a time of intense labor scarcity and wage inflation in 1H22. To this point, we have seen the latter as ACHC has added less than 50 organic beds in the past two quarters. However, despite these results, the stock has managed through the tough #Quad4 environment on the long- term tailwinds tied to probable labor inflation easing over the back half of FY22 and the company’s growing CTC business.
In recent weeks, the EV/NTM EBITDA multiple has returned to the top of it’s historical range from 14.3x in April to 13.0x today and short interest has crept up from roughly 3% to 4%. The factor set up in #Quad4 is essentially neutral with the positives of size, liquidity, and margin factors balanced by the negatives of short interest and estimate momentum. Nonetheless, this landscape provides further immediate downside to the current price. ACHC's estimate trend is in MicroQuad 4, below average slope and acceleration, but is forecasted to accelerate from June to October and MicroQuad 2 through the rest of FY22.
Thesis
The decision to move ACHC from the short bench to the long bench is the result of a series of positive signs of easing for the tense staffing environment in healthcare and the potential strength of the CTC business in a post- COVID environment. Beginning with the outlook for labor, we have seen ACHC manage successfully through recent headwinds by preserving SWB margin at historic levels by leveraging both LPN’s and counselors across their service lines, as well as at least one report of recruiting local security to maintain order within facilities.
Additionally, we have seen a recovery in the mix of unemployed RN’s to employed in recent months, indicating that due to waning savings or reduced fear in returning to work has increased the supply of available hires. Lastly, in field checks over the past few weeks, hospital executives have described multiple credible factors driving easing wage pressures into 2H22, and a 10-15% premium over 2019 levels as current agency labor contracts expire. The combination of these characteristics is a positive for ACHC beginning in 2H22.
A key element in our positioning change resulted from further analysis we conducted on the CTC business following elevated interest and additional disclosures on the 1Q22 earnings call. After better understanding the type of patient, costs and duration of programs, and the company’s limited KPI’s, we have incorporated these metrics into our model, which was already working well and within $1MM of ACHC’s reported 1Q22 result.
Patients seeking treatment at an outpatient rehab facility are often self-referred or court mandated, employed, and enroll in a 30-to-90-day program that costs between $3k and $10k per month (with the average being $5k). The mix of insurance types is roughly 45% self-pay, 35%. Medicaid, 15% commercial, and 5% Medicare based on an application summary for the South Nashville Comprehensive Treatment Center in December 2020. From what we understand about the business, we believe the set-up is well- positioned for the post- COVID environment of higher acuity patients carrying additional stresses as they “return to normal.” Demand for these services will likely remain high during #Quad 4. Additionally, CTC facility staffing will likely remain more manageable given the relatively lower need for specialized licensure based on the taxonomy codes of the employees who operate them compared to inpatient facilities.
The aforementioned points of fundamental strength for the underlying business coupled with the positive results from our factor analysis, we have decided to move ACHC to our long bench in expectation of an immediate term price regression followed by a favorable set-up for the 2Q22 print. With our restructured tracking tools and visibility into the CTC trend, we expect to be able to monitor the data for upside into earnings and the potential for increased optimism for 2H22.
Valuation
Based on our estimates and utilizing ACHC’s historical EV/NTM EBITDA range of 10-15x, the upside scenario is modest at 10-20% from the current price. Although, the current #Quad4 environment, which is expected to persist throughout FY22, should pin down the share price in the coming weeks and may provide an opportunity for greater upside. For this reason, we have chosen to add ACHC to our long bench and will wait to be informed by our trackers before pushing the name to an active long.
Catalysts
- Current Population Survey (CPS) Data on Nurse Supply & Employment Status | On the company's 4Q21 earnings call, they stated that the labor market was tight now and would be through 1H22, but expected the situation to ease in the back half. While we had originally believed that would extend through FY22 and possibly 1H23, labor tightness looks to be easing from the data we follow for registered nurses from the Current Population Survey (CPS). We will continue to monitor the situation, but the more that scarcity alleviates, the easier it will be for ACHC to find suitable candidates to staff their facilities and continue the expansion plans they've guided to.
- Hedgeye Locations Tracker and Provider Count | The ACHC Locations Tracker has been incredibly accurate in measuring the pace of bed expansions for both the individual service lines and the business as a whole, because the company maintains a rough 3x ratio of beds to NPI- holding staff. The latest tracker result for 1Q22 in April was a large component in our decision to move ACHC from an active short to a bench short in April of 2022. We will continue to monitor the data for new hires and attrition.
- Forecast Algorithms for US Facility Admissions and Revenue per Patient Day | We have used our forecast algorithm tool in the past to predict the US Facility Admissions in the near- term with directional clarity. After recent modifications of our model to account for the growing prevalence of the CTC business, we now believe we will be able to expand the tool's use to gain insights in pricing for both the CTC and remaining business lines. We will inform subscribers of these updates and the change to the assumptions in our model once they are completed later in the quarter.
- 2Q22 Earnings Release, Call, and Guidance | The next earnings event is a significant catalyst in our positioning change. While we are moving ACHC to long bench today, we do not believe the current price is the best entry point to initiate a new position. Following additional drawdown in the quarter (and providing us time to update our internal trackers), we believe the data will validate a long thesis closer to the 2Q22 earnings call. We expect the call to take place in August.
Risks
- Additional COVID Waves Delay Return to Normal Admissions | ACHC has pointed out disruptions in admissions due to the presence of COVID variants throughout the pandemic offset by longer than historical lengths of stay. While we do not expect subsequent waves to have nearly the level of hospitalizations or "media frenzy" as those in the past, the emergence of subsequent variants could delay the arrival of new patients. We believe this to be a minor risk to the long thesis, but one we monitor daily.
- Providers Choose More Favorable Work Settings After COVID Has Subsided | We often remarked on the unfavorable working and attending environment of inpatient mental health facilities based on former employee anecdotes, Glassdoor reviews, and our own investigation. For these reasons, we have not altered our view that these facilities are not preferred by employees, but management's ability to attract and retain talent eases our concern going forward. CTC staffing is less difficult, but can only drive part of the incremental growth.
Key Slides
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Thomas Tobin
Managing Director
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