PSB Monthly Issue April 2012

As baby boomers age, they’re skewing our demographics older.  And an increasing senior population can only mean one thing… demand for healthcare is going to skyrocket in the years ahead.

It’s just a fact of life.  As we age, we need more care, services, pills, creams, and everything else to keep going.

And, of course, the companies who provide those essentials are going make some serious cash as demand for their products and services increase.

One service sure to be in high demand as our population ages is long-term care.

The industry basically sinks or swims based on how much money these two giants are willing to pay out.  And last year they threw a wrench into things when they changed how they paid long term care providers for the services they provided.

What’s more, the industry is under a cloud of uncertainty from Obamacare’s future hanging in the balance…

Clearly, there have been and always will be challenges for the industry.  However, well run companies find a way to succeed in any market environment.

One undervalued long-term care facility operator with a knack for succeeding is Sun Healthcare Group (NASDAQ: SUNH).

THE LONG-TERM CARE FACILITIES BUSINESS

SUNH is a healthcare services company with approximately 29,000 employees in 46 states.  Sun’s services are provided through its subsidiaries.

In November of 2010, the company spun off their real estate assets into Sabra Health Care REIT (SBRA).  Now SUNH leases its formerly owned facilities and pays Sabra rent.

SunBridge Healthcare is the core business. They operate 165 skilled nursing centers, 14 combined skilled nursing, assisted and independent living centers, ten assisted living centers, two independent living centers and eight mental health centers with an aggregate of 22,860 licensed beds in 25 states.

They also have three divisions that complement their core business.  SunDance Rehabilitation provides rehabilitation therapy services to affiliated and non-affiliated centers in 36 states.  CareerStaff Unlimited provides medical staffing services in 40 states.  And SolAmor Hospiceprovided hospice services in 11 states.

At this moment, they have a number of strengths that are fueling their success…

As I said, Medicare and Medicaid changed the game last year.  But SUNH has done a great job of adjusting to the new rules. In fact, they’ve been able to adapt to them quicker than expected.

Obviously this speaks volumes about the management team SUNH has in place.  And in an industry where big government controls the money, it’s essential to have a strong management team capable of dealing with these curve balls.

Here’s something else to keep in mind…

SUNH also has top notch facilities and they provide high quality care.  And they have shown the ability to consistently grow by attracting more and more patients to their facilities.

Now SUNH is on the verge of another growth spurt.  They’re expanding their core services and increasing their complementary businesses to fuel growth.

Here’s where it get’s exciting…

Sun’s investment in Rehab Recovery Suites is an important part of their growth story. They brought four units online during the fourth quarter.  Now they have 75 Rehab Recovery Suites with 2,308 beds.  An eye-popping 16% year-over-year increase… with more units on the way this year.

Simply put, Sun’s growing rehabilitation services and hospice care have the potential to fuel growth far beyond what they’re being given credit for.

Let’s take a closer look at the company’s financials.

THE NUMBERS

SUNH finished 2011 on a down note.  They had to suspend 2011 financial guidance in August after the Centers for Medicare and Medicaid Services issued a new rule for paying nursing homes.

After reviewing the rule, they slashed their 2011 earnings guidance from a range of $1.30 to $1.45 to between $0.83 and $0.94.  But after quickly adjusting, SUNH was able to deliver $1.04 in earnings for the entire year.  A significant earnings beat any way you slice it.

Make no mistake, the 11.1% Medicare rate cut hurt their nursing home business.  We’ll see it reflected in weaker revenue and earnings in 2012.

But don’t be alarmed… It’s bound to happen when 71% of you revenue comes from Medicare and Medicaid.  But keep in mind, these cuts are already priced into the stock…

Now investors are focusing on how the company will perform going forward.  And they’ve got a lot to be excited about.

For instance, the SolAmor Hospice division grew revenue by an astounding 26% last quarter.  And SunDance Rehabilitation increased revenue by 21%.  And they’ll have an additional 200 beds available sometime this year.

Overall, Sun’s expected to begin seeing overall revenue growth resume next year.  And they’re expected to average 11.5% growth per year over the next five years.

Better yet, the balance sheet is rock solid.

SUNH has $58 million in cash and $89 million in long-term debt.  More importantly, they have a current ratio of 1.7.  So they should have no trouble meeting short term liquidity needs.

INVESTMENT RISKS

As with any investment, Sun Healthcare Group has a few risks.

Additional cuts to Medicare reimbursement rates would hurt SUNH revenue and earnings.

Another risk comes from revisions to the Medicare RUG payment system.

Finally, they could be hurt by Federal Government budget cuts that result in lower Medicare and Medicaid payments.

POTENTIAL RETURN OF 105% OR MORE

SUNH is significantly mis-valued by the market.

Right now, SUNH is trading at only 10x projected earnings.  That’s a huge discount to the industry average PE of 19x.

If SUNH were to trade up to the industry average PE, it could surge 90%!

What’s more, SUNH’s new growth businesses are being undervalued.  If they get the credit they deserve, the stock could easily double from here.

Based on our analysis, we see the stock trading up to at least $14.00.  Grab your shares of SUNH now for potential gains of 105%!

ACTION RECOMMENDATION

BUY Sun Healthcare Group (NASDAQ: SUNH) up to $7.50 per share.