A Fast Growing But Strange Recession Resistant Stock
Chuck is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Chemed Corp. (NYSE: CHE) combines two completely unrelated businesses into a very profitable enterprise. Approximately 70% to 75% of their business is VITAS Healthcare Corporation, the nation’s largest provider of end-of-life hospice care services. Headquartered in Miami, Florida, VITAS serves patients through hospice programs in major metropolitan markets in 12 states: Arizona, California, Connecticut, Delaware, Florida, Georgia, Illinois, New Jersey, Ohio, Pennsylvania, Texas, and Wisconsin.
Their second wholly-owned subsidiary is, oddly enough, Roto-Rooter, which represents approximately 25% to 27% of their business. Roto-Rooter is the largest provider of plumbing and drain cleaning services in North America. Roto-Rooter has approximately 110 company-owned branches and approximately 500 franchisees. Additionally, Roto-Rooter provides repair and maintenance services to residential and commercial markets.
At first, the only thing I really saw in common between these two subsidiaries is that they are both the Nation’s largest in their respective industry. Through additional research, I discovered that Chemed’s roots (pun intended) originally are from Roto-Rooter. In 1986 Roto-Rooter was spun off with Chemed maintaining a majority interest, only to be re-aquired in August 1996. Apparently, Chemed remains interested in divesting themselves of the Roto-Rooter subsidiary. However, it appears that the company is having trouble monetizing Roto-Rooter at a fair value. But management continues to weigh various options such as consolidating franchisees and even another tax-free spin-off to current shareholders.
Chemed Corp: Fundamental Valuation
The following earnings only review of Chemed through the lens of F.A.S.T. Graphs™ reveals that the company accomplished a major operating inflection point starting in calendar year 2004. After struggling a little bit in the late 1990s and through the recession of 2001, Chemed has posted consistent and strong earnings growth that averaged over 29% per year. However, this average was inflated by two consecutive years of earnings growth of over 80% per annum (2004 and 2005-see highlights below the graph).
The following earnings and price correlated F.A.S.T. Graphs™ since calendar year 2007 illustrates a more realistic earnings growth rate of 16.3% per annum for Chemed. With this graphic we see that over the long run price, (the black line) has tracked earnings (the orange line). Moreover, over shorter periods of time when price becomes disconnected from earnings it soon moves back into alignment. Therefore, the company’s current blended PE ratio of only 12.2 indicates that Chemed is currently undervalued.
The consensus of five analysts reporting to Standard & Poor’s Capital IQ forecast that Chemed should grow earnings at 15% per annum over the next five years. However, estimates for fiscal 2013 are only calling for approximately 3% growth over the shorter term. Nevertheless, mathematically speaking Chemed represents an attractive and undervalued investment opportunity at this time.
Competition
Chemed is the most difficult company I have ever come across to measure against its competition. Do you compare it to a plumbing supplier like W.W. Granger (NYSE: GWW) or to the plumbing division of Federal Signal (NYSE: FSS), or to healthcare companies like Almost Family (NASDAQ: AFAM) or Amedisys Inc. (NASDAQ: AMED)? The decision was too foolish to make, so I compared Chemed to both categories. The following table shows that Chemed is forecast to generate the highest annual total rate of return of the group.
Caveats and Risks
Even though Chemed’s recent operating results have been consistently strong, there may be some clogs in the earnings pipeline. Vitas Healthcare Corp., Chemed’s hospice unit, has been accused of Medicare fraud in a Texas whistleblower case prompting a series of distracting lawsuits. Chemed management vigorously denies the charges, and so far analysts are supportive. Additionally, the Roto-Rooter division has been accused of labor infractions.
However, the greatest risk may be the company’s dependence on Medicare reimbursement itself. It has been reported that the Centers for Medicaid and Medicare (CMS) are considering reducing benefits for hospice. Since hospice receives the bulk of their reimbursements from Medicare, a reduction in reimbursements could greatly impact future profitability. On the other hand, an aging population provides a long-term opportunity for hospice companies such as VITAS Healthcare Corporation.
Summary Conclusions
At first glance Chemed Corp. appears to be a very profitable company with a bright future and a stock that is currently undervalued. On the other hand, there are risks of potential Medicare and Medicaid reimbursement cuts that could potentially interrupt long-term future profitability. Furthermore, the odd marriage of VITAS Healthcare Corporation and Roto-Rooter appears problematic. Roto-Rooter has recently been a drain that may soon be flushed out.
On the flipside, assuming they can divest Roto-Rooter profitably, the company would be freeing up their cash flow to pay down debt, buyback shares and/or increase dividends. As previously stated, the demographic opportunity for hospice services is clearly large and increasing. Consequently, there remains a long-term opportunity for profit in this important marketplace. Nevertheless, potential investors should recognize the realities of the risk reward ratio of investing in Chemed Corp.
ChuckCarnevale has no positions in the stocks mentioned above. The Motley Fool owns shares of Almost Family. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
