AMED Sell-Off To Continue; No Reason To Own as Estimates are Still Too High

Amedisys, Inc. (NASDAQ:AMED) took a 9% hit Monday, as the company announced a major restructuring of its home health services agreement with Humana (NYSE:HUM). HUM is estimated to be the company’s largest relationship in the managed care segment. Based on the new terms in which HUM will now reimburse the company for patients on a “per-visit” basis, rather than on an “episodic” basis (more billing opportunities), AMED expects that the HUM contract will now result in half of the revenues that the company was previously receiving from this agreement (half of $65-$70 million per year, or approximately 5% of net service revenues). The company also mentioned that the new HUM agreement encompasses fewer markets than the prior agreement, so AMED has lost market share. The new reimbursement agreement begins immediately (dated Oct. 1st), however, the biggest hit to earnings should be felt next year.

While the company had initially indicated to investors that it could lose the entire HUM contract, most analysts were not modeling in a major loss of revenues and earnings, hence the market’s negative reaction to yesterday’s news. We think the damage is far from over, and many analysts still appear to be taking the HUM news in stride. While analysts predict anywhere from a $0.06 – $0.15 impact to EPS in 2013, most have yet to officially bring their earnings estimates down. With the Consensus EPS estimate on AMED for 2013 still at $0.93 (down from $0.96 prior to the HUM announcement), we believe 2013 EPS guidance remains a key risk to the story. The impact to earnings could be worse than most analysts are estimating, with the potential for downward earnings revisions of about a 25% relative to the current Consensus expectations. Bears on the story are modeling in EPS for the company in the $0.60-$0.70 range for 2013, as reduced revenue and lower margins both negatively impact the bottom line. Using a 10x multiple on AMED’s deteriorating earnings outlook, and applying that multiple to the low end of “Bearish” earnings expectations, AMED has the potential to trade down to the $6.00 level. If the Bears’ EPS estimate range of $0.60-$0.70 is correct, then shares of AMED look really expensive at nearly 20x forward earnings. Paying 20x declining earnings makes no sense, and as a result, shares of AMED are likely to continue to bleed lower into the company’s 3Q earnings report. Note that the company is anticipated to release earnings in the first week of November, and this could be when the rubber meets the road for AMED and its financial outlook.

AMED’s contract with HUM was signed in 2010, and payment to AMED on a per-episode, rather than a per-visit basis was a sweet deal. The “per-episode” terms enabled AMED to treat patients covered by HUM like Medicare insured patients, with the ability to “optimize” (aka reduce) visits to lower costs, and therefore derive better profit margins. According to industry analysts, HUM’s own earnings pressure may have been the driver of the restructured agreement.

The challenge for AMED is that the “per-visit” reimbursement policy means that direct healthcare delivery costs (medical professional wages, medical supplies) will be associated with each billing activity, significantly reducing margins. Adjusting these costs will be difficult, if not impossible under this reimbursement structure. As a result, the company may try to reduce non-clinical staffing costs (billing, collections, call center expenses) to partially offset the high costs per unit of reimbursement. The company’s guidance yesterday that half of revenues will likely disappear, in our view, indicates just how much excess billing may have existed under the former “episodic” reimbursement agreement, and the expected reduction in profit margins have potential to hit the bottom line hard. The impact of the Humana rate cut, as well as the expected 2% Medicare rate reduction next year make it difficult for AMED to mitigate the EPS hit.

One analyst believes that 2013 earnings could be as low as $0.40 per share if AMED is unable to manage the twin issues of the HUM restructuring and Medicare cuts. Rubbing salt into the wound, AMED has $60 million of debt that comes due in March 2013, another overhang that shareholders must deal with.

Given that earnings estimates that are likely to come down further when the company reports early next month; the negative business outlook for home health companies in general due to ongoing sector volume weakness; and ongoing Medicare and commercial insurance rate pressures; investors are likely to dump shares of AMED and seek a better entry point, perhaps when the shares fall to the mid-single digit level.