Rising Regulatory Pressures And Labor Cost Hikes Will Compress Margins

Key Takeaways

• Exposure to regulatory changes, labor shortages, and reimbursement pressures is eroding margins and destabilizing predictable revenue across core business operations.
  
• Industry shifts toward telehealth and payer consolidation are shrinking Select Medical’s addressable market and curbing future growth opportunities.
  
• Strategic expansion, partnerships, technology investments, and operational discipline are expected to boost patient volumes, efficiency, and long-term profitability despite short-term regulatory headwinds.

Catalysts

Through its subsidiaries, operates critical illness recovery hospitals, rehabilitation hospitals, and outpatient rehabilitation clinics in the United States.

• Intensifying regulatory pressures, including persistent increases in the high-cost outlier threshold and implementation of the 20% transmittal rule for critical illness recovery hospitals, are sharply eroding profit margins and undermining revenue predictability; with proposed CMS rules only partially offsetting these headwinds, future earnings are likely to remain volatile and structurally impaired.
  
• Heavy reliance on Medicare and Medicaid reimbursement leaves Select Medical acutely exposed to further policy changes, rate cuts, and unpredictable regulatory shifts, which could drive recurring net revenue declines and margin compression across inpatient and outpatient divisions.
  
• The accelerated industry shift toward telehealth and virtual care threatens to structurally reduce demand for facility-based rehabilitation and specialty hospitals, shrinking Select's long-term addressable market and impeding sustainable volume and top-line growth as more care migrates away from traditional settings.
  
• Wage inflation and persistent labor shortages within the healthcare workforce continue to drive up operating costs, outpacing reimbursement improvements and further squeezing net margins, particularly as Select Medical attempts to manage rapid network expansion and new capacity coming online.
  
• As commercial payers and providers consolidate, bargaining power is increasingly concentrated among large insurers, putting downward pressure on reimbursement rates for post-acute providers and intensifying utilization management, which constricts patient inflows and suppresses both revenue and profitability prospects for Select Medical over the long-term.

Select Medical Holdings Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Select Medical Holdings compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Select Medical Holdings's revenue will grow by 4.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 1.2% today to 3.0% in 3 years time.
• The bearish analysts expect earnings to reach $182.2 million (and earnings per share of $1.4) by about May 2028, up from $60.8 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.7x on those 2028 earnings, down from 31.6x today. This future PE is lower than the current PE for the US Healthcare industry at 20.4x.
• Analysts expect the number of shares outstanding to decline by 1.15% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.5%, as per the Simply Wall St company report.

Select Medical Holdings Future Earnings Per Share Growth

Risks

• The inpatient rehabilitation division is experiencing significant growth with robust development plans, including 440 additional beds opening between 2025 and 2027, which positions Select Medical to capture increasing demand from the aging population, likely expanding long-term revenue and supporting higher earnings.
  
• Strategic partnerships and joint ventures with major health systems such as UPMC, Banner, Cleveland Clinic, and Cox Health Systems are broadening Select Medical’s referral network and market reach, which could drive incremental patient volumes and bolster revenue growth.
  
• Despite short-term reimbursement pressures and regulatory challenges in critical illness recovery and outpatient divisions, CMS has proposed rate increases for both segments that, if finalized, could improve reimbursement rates and directly support future margin and earnings recovery.
  
• The company’s ongoing investment in technology, including the rollout of productivity-boosting software in the outpatient division and continuous improvements, is showing benefits and is expected to deliver steady margin improvement and operating efficiency, potentially enhancing net margins and profitability.
  
• Select Medical’s demonstrated ability to optimize its outpatient network through clinic closures, consolidations, and targeted expansion suggests prudent capital deployment and operational discipline, which may lead to sustained improvement in return on invested capital and overall earnings growth.

Valuation

• The assumed bearish price target for Select Medical Holdings is $15.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Select Medical Holdings's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $25.0, and the most bearish reporting a price target of just $15.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $6.0 billion, earnings will come to $182.2 million, and it would be trading on a PE ratio of 12.7x, assuming you use a discount rate of 7.5%.
  
• Given the current share price of $14.92, the bearish analyst price target of $15.0 is 0.5% higher. The relatively low difference between the current share price and the analyst bearish price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.