Rehab Hospital Expansion Will Affect Future Prospects Though Debt May Pose Risks

Key Takeaways

• Effective debt reduction strategies and expansion in inpatient rehab position Select Medical for revenue growth and improved financial performance.
  
• Strategic capital deployment and cost management enhance profitability, with potential growth from outpatient expansion and reduced labor costs.
  
• Debt load and expansion efforts may strain profitability, as start-up losses and declining occupancy rates challenge revenue growth and cash flow stability.

Catalysts

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

• The successful initial public offering (IPO) of Concentra and the subsequent debt financing arrangements have allowed Select Medical to significantly reduce its debt, lowering the consolidated leverage from 4.13x to 3.38x. This reduction strengthens the financial position and is likely to positively impact net margins and future earnings.
  
• Robust development plans in the inpatient rehabilitation division, including new hospital openings and bed expansions, are expected to add 569 additional beds by 2026. This expansion is poised to drive revenue growth and increase adjusted EBITDA through increased patient volumes and improved occupancy rates.
  
• The company's outpatient rehab division is seeing growth with the addition of new clinics and plans for further expansion, which include opening new clinics and increasing patient access. This is likely to enhance revenue through increased patient volumes and improve profitability due to advancements in clinical efficiency, thus impacting net margins favorably.
  
• Select Medical is experiencing improvements in labor costs across its divisions, notably a reduction in nursing agency costs and utilization. Stabilizing these costs contributes to improved net margins and boosts overall financial performance.
  
• Select Medical's focus on maintaining a consolidated leverage ratio of around 3x and its history of opportunistic capital deployment suggest the potential for future growth through strategic developments, stock buybacks, and further debt reduction, all of which can positively impact earnings per share (EPS).

Select Medical Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Select Medical Holdings's revenue will grow by 4.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 3.8% today to 2.0% in 3 years time.
• Analysts expect earnings to reach $157.0 million (and earnings per share of $1.83) by about December 2027, down from $265.8 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 23.2x on those 2027 earnings, up from 9.6x today. This future PE is lower than the current PE for the US Healthcare industry at 23.7x.
• Analysts expect the number of shares outstanding to decline by 12.64% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.69%, as per the Simply Wall St company report.

Select Medical Holdings Future Earnings Per Share Growth

Risks

• The substantial debt load, highlighted by a consolidated debt balance of $3.1 billion, could strain future earnings and cash flow as interest expenses remain high, potentially impacting net margins.
  
• Ongoing construction and expansion projects such as new rehab hospital openings could lead to increased capital expenditures, which may affect free cash flow and overall profitability if not managed well.
  
• Start-up losses from new hospital projects, as noted in the inpatient rehab division, could continue impacting net margins and overall profitability if new hospitals do not quickly become financially viable.
  
• Revenue impacts from closures of underperforming clinics, despite offsetting new openings, could pose a challenge in maintaining or growing outpatient division revenue.
  
• Declining occupancy rates in certain divisions, such as a reduction in occupancy in the inpatient rehab hospital division due to new hospital start-ups, might hinder revenue growth and profitability if the new capacity is underutilized.

Valuation

• The analysts have a consensus price target of $34.25 for Select Medical Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $47.0, and the most bearish reporting a price target of just $24.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $7.8 billion, earnings will come to $157.0 million, and it would be trading on a PE ratio of 23.2x, assuming you use a discount rate of 7.7%.
• Given the current share price of $19.68, the analyst's price target of $34.25 is 42.5% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• 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.