National HealthCare Corporation

Moat: 1/5

Understandability: 2/5

Balance Sheet Health: 4/5

National HealthCare Corporation (NHC) is a leading provider of long-term healthcare services, operating a network of facilities that include skilled nursing facilities, assisted living facilities, independent living facilities, home care agencies, hospices, and rehabilitation services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

NHC primarily operates in the healthcare sector, providing a mix of long-term care services, which range from skilled nursing to independent living and more recently behavioral health and other ancillary services, serving diverse healthcare needs across the United States. The company’s revenues and profits are heavily reliant on government programs like Medicare and Medicaid.

Business Description

National HealthCare Corporation (NHC), established in 1970, is a healthcare company that primarily operates skilled nursing facilities (SNFs), assisted living facilities, independent living facilities, home healthcare agencies, rehabilitation centers, and hospices, mostly in the southeastern part of the United States. NHC also offers management services to other healthcare providers and has branched out into other ancillary operations like pharmacy.

Revenue Distribution

  • Skilled Nursing Facilities: These facilities provide 24-hour nursing care for people with chronic illnesses or recovery from surgery, making it the biggest source of revenue for NHC. The revenue is generated by payments from Medicare, Medicaid and private pay.

  • Assisted Living Facilities: These facilities offer housing and assistance with daily living for older adults.

  • Independent Living Facilities: These facilities provide a living area but less than assisted living.
  • Home Health Agencies: Home health agencies provide services to people in their homes. This is a small but growing part of NHC’s business.

  • Behavioral Health: These services focus on treatment of behavioral health.

  • Hospice Agencies: Hospices provide care and support for individuals with life limiting illnesses.

The healthcare industry, especially long-term care is experiencing significant change due to aging demographics and the increasing prevalence of chronic disease, which increases the demand for these services. Also, there is a shift towards home and community-based services because of rising patient preferences and a desire to provide healthcare in a less costly manner.

  • Competitive landscape: The industry is highly competitive, with competition from local, regional, and national operators. Competitors include other major nursing home operators, small regional providers, and hospitals offering post-acute care. In addition, the market is influenced by a wide variety of regulations, particularly from federal and state governments.

  • Differentiation Factors: The differentiating factors for companies in this industry typically include providing better quality care or customer services, unique treatment programs, or having a wide-reaching, reputable brand.

Moat Assessment

NHC has very weak or negligible moat. The healthcare industry, in general, has low barriers to entry in many areas, such as home care, assisted living, and other smaller segments. The competitive intensity has resulted in high customer churn and lower pricing power for companies. It does have slight advantages in its brand and operational expertise, which allows it to get its fair share in its markets. Overall, no economic moat is discernible for the company. Moat Rating: 1/5

  • The company has some intangible brand advantages, which have been developed over decades. But these advantages are weak and may be broken by any innovative competitor.
  • There are no switching costs for patients and clients. They can move between different providers easily.
  • The company does not benefit from the network effect or any significant economies of scale.
  • While the company has expertise, they do not have any technological competitive advantage.
  • There are many providers in the space with nearly identical offerings.

Risks to the Moat and Business Resilience

The following are the primary risks to the long-term growth of the business.

  • Regulatory Changes: Changes in Medicare and Medicaid reimbursement rates, government regulations for safety and operations, or new rules imposed by state boards might negatively impact revenues and profits. Given its reliance on government pay, the company is very vulnerable to such factors.
  • Labor Costs: The healthcare industry has been facing a labor shortage for a while now. Staff wages are rising, which creates cost pressures, particularly for nursing home operators.
  • Competition: The healthcare industry is very competitive. New competitors may enter and existing competitors may offer better, low cost offerings that may take the market share of NHC.
  • Technology Disruption: The advent of better, remote health solutions and new technology in patient care may disrupt the way that NHC provides its services and create cost pressures.

Despite these risks, some aspects of NHC’s business provide resilience:

  • Defensive Industry: Healthcare is a defensive sector because its demand is stable during both good and bad times.
  • High Demand: The demand for healthcare for the elderly is likely to increase due to increasing demographics.
  • Management Experience: NHC has an experienced management team who knows the healthcare industry well.

Financial Analysis

Here’s a detailed analysis of NHC’s financials based on its recent and past results:

Revenues:

  • NHC’s revenues have steadily increased over the past several years, primarily driven by occupancy rates in their facilities, rates in care, and expansion into new markets. The government payments (Medicare and Medicaid) are one of their most important source of income and their changes are extremely impactful on their revenues.
  • In 2022, the company’s revenues increased by approximately 12% Y/Y. In the past, their revenue growth has been steady but a little slow, while their operating profits and net profits were much more volatile. Revenue growth during the last 1-2 years have been much stronger compared to the previous years.
  • The three months ended March 31, 2023 saw a revenue growth from $277 million to $301 million, an increase of 8.6%. The nine months ended September 30, 2023 has seen a revenue increase of $810M to 902M, an increase of approximately 11%. There was solid growth in their revenue Y/Y in the most recent quarters.
  • Revenue is very impacted by regulatory changes (as they mostly get paid by the government). We should see a decline in government payments as temporary incentives that were put in place due to COVID ends, and as the company reduces its dependence on Medicare and Medicaid.

Profitability:

  • Gross and operating margins fluctuate widely over the years and is very much impacted by labor costs and reimbursement rates. Gross margins were quite good, at 35% in 2022, while their net margins were 3.7%.
  • There has been a slight decline in profitability over the past years due to various operational factors and due to a decrease in government reimbursement.
  • Their most recent quarterly numbers showed operating profit increasing to 37.9M while net income decreased slightly. For the nine-month period, they have improved their operating income but also increased their total costs.

Capital Structure:

  • NHC has a good debt profile. In the last quarterly balance sheet (3Q-2024), their debt to equity ratio was around 1.08. They have a debt of roughly 1.1 billion dollars, while their total assets are roughly $1.6 billion dollars.
  • The long-term debt to equity ratio has stayed around one from the past few years. The company has been able to generate enough cash flow to finance their business.
  • Currently, their operating cash flow is 129M.

Important Financial Ratios:

  • Return on equity (ROE): Around 8-10% (has fallen over the years)
  • Return on Invested Capital (ROIC) ~ 6 to 8% with heavy fluctuation (with and without goodwill).
  • Debt to capital ratio - Around 0.4 to 0.5 (has been increasing recently).
  • Interest coverage ratio: Good.

Recent Concerns and Controversies:

  • Government Funding Cuts: As the Covid emergency is ending, one of the major concerns is the discontinuation of temporary stimulus measures and reimbursements from government programs like Medicare and Medicaid. This will likely affect their margins and profitability.
  • Staffing Shortages: The biggest problem the company is facing right now is attracting enough high-quality nurses and other staff. As wages increase, the profitability of the business decreases.
  • Labor Costs: As mentioned earlier, costs have been increasing for NHC.

Understandability

NHC is a somewhat complex company, mainly because of accounting challenges in their financials and the nature of the healthcare industry itself. Although they provide easy-to-understand services, their financials are not very transparent, require a lot of restructuring to properly reflect their income and earnings, and are heavily influenced by factors that are very hard to predict. For these reasons, I have rated the understandability of the business as 2/5.

  • The company has multiple revenue segments with different business drivers. It may take some effort to fully understand each part of their business.
  • The company operates in a heavily regulated industry, making it difficult to form a clear picture of its long term prospects.
  • Their financials involve significant amount of estimates, adjustments, and complicated accounting. The use of accounting jargon will make it hard for beginners to analyze the business.
  • The company is highly influenced by various external factors (government and economy) and changes in those are difficult to predict or understand.

Balance Sheet Health

NHC’s balance sheet is relatively healthy. They do have high debt, but that is offset by their operating cash flow. They are not taking on too much debt that may cripple the company, and they seem like they can handle the debt obligations that they have. Rating: 4/5

  • They have consistent cash generation.
  • Their debt is high, but they have sufficient capacity to maintain it.
  • They have some investments they can tap into if required.
  • Their tangible assets are stable and growing.
  • Their debt profile is decent given the nature of the industry they are in, with more of the debt having a long-term nature.