Select Medical Holdings Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Select Medical Holdings Corporation operates a network of critical illness recovery, rehabilitation, and outpatient therapy facilities across the United States.

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.

Select Medical Holdings Corporation (SEM) operates a network of critical illness recovery, rehabilitation, and outpatient therapy facilities across the United States. The company is structured into four reportable segments: Critical Illness Recovery Hospital, Rehabilitation Hospital, Outpatient Clinics, and Concentra.

Business Explanation

Select Medical’s revenue streams are diversified across its four segments: Critical Illness Recovery (43% of revenue), Rehabilitation (23% of revenue), Outpatient (18% of revenue) and Concentra (16% of revenue).

Critical Illness Recovery Hospitals (IRFs): These are long-term acute care hospitals that provide specialized care for critically ill patients with complex medical conditions who typically require extended stays of 25+ days.
Rehabilitation Hospitals (RHs): These are inpatient rehabilitation facilities that provide intensive rehabilitation services to patients recovering from strokes, traumatic brain injuries, and other serious medical conditions.
Outpatient Clinics: The outpatient division provides physical, occupational, and speech therapy services to patients in outpatient settings.
Concentra: This business division manages occupational health centers and onsite clinics which offers a variety of workplace health services including occupational medicine, urgent care, and physical therapy.

This diverse setup allows Select to benefit from a broad array of healthcare revenue streams and reduces their risk to only one area.

Industry Analysis The healthcare sector is facing several tailwinds, mainly driven by an aging population and increased prevalence of chronic diseases. This is leading to higher demand for recovery, rehabilitation, and specialized medical services. There’s also a growing need for healthcare access and a high percentage of chronic illness that creates growth in demand of their services. However, this industry is also highly regulated, with the government playing a key role. The impact of public policy, like Medicare payment rates, is critical to the profitability of such facilities. This means they are always operating with a sword above their head, as new rules and payments can have a substantial impact in one quarter. The industry is also facing shortages of labor, which are increasing costs and decreasing service quality.

Another important part of this is also to provide long term support with these kind of facilities, there will always be a need for care facilities even as the baby boomer population shrinks

Competitive Landscape The healthcare industry is competitive and fragmented, with both national and regional chains. These providers do not offer the same services nor compete on the same patients. Some specialize in particular segments of care, for example, Select Medical has a large presence in IRFs but less in outpatient care. Competition includes large national hospital chains, regional hospitals, specialized recovery centers and rehabilitation centers. It also contains large amount of regional mom and pop clinics. Their biggest competitors are Encompass Health, Kindred Healthcare and LifePoint Health. Select Medical differentiates itself by operating a diversified mix of healthcare services and providing a consistent level of high-quality care, and by their ability to have a strong national network. Their ability to provide multiple levels of care and their strong integration, while not unique, does give them a leg up on competitors.

Moat Analysis: 2/5

Select Medical’s moat is fairly narrow as of 2024. A moat rating of 2/5 is given to Select as there is SOME competitive advantage but it’s not as stable and consistent for large periods of time.

Some Scale Advantages: Select Medical benefits from its large scale, which allows them to operate efficiently. They have significant facilities and geographical coverage. This scale gives them some advantage over smaller regional players that might not have the same resources.
Reputational Advantage: Select Medical has a well-established brand name with a reputation for high-quality care, which allows them to attract and retain patients.
Long-Term Relationships with Payors: Select has long-term relationships with major payors, which provide them with predictable revenue.
Barriers to Entry: Entry to the industry requires significant capital expenditures, regulatory approvals, and staffing considerations, which act as some barrier for new competitors.
Low Customer Switching Costs: For many patients, switching to other similar care facilities is not that difficult, since many facilities provide similar options.
Limited Pricing Power: Select Medical has limited pricing power due to government regulations and reliance on Medicare and managed care contracts.

Overall, these factors combine for a narrow competitive advantage that may provide better than average returns, but their reliance on Medicare and other government payors provides a cap on potential profitability.

Risks to the Moat and Business Resilience

Here are legitimate risks that can be attributed to the moat.

Regulatory Risk: Changes in healthcare regulations or reimbursement policies can significantly impact the company’s revenue and profitability.
Pricing Pressures: As Medicare spending growth slows and as new payment programs are created by Medicare, or as insurance companies become more dominant, the company’s power to negotiate rates might fall.
Economic Risk: A slow economy with increased joblessness and limited disposable income of consumers might decrease the amount people use their facilities, while increasing the difficulty in keeping the staff.
Competition: Increased competition from other providers can erode the company’s market share.
Technological Disruption: New technologies may change how people access and pay for healthcare, and can make some of Select’s services obsolete or undesirable.
Labor Shortage: Increased competition for healthcare professionals and a lack of staff leads to higher operating costs.
Dependence on Government Payors: A large part of Select’s revenue is dependent on government payors such as Medicare and Medicaid, meaning they do not have the ability to raise prices.
Economic Slowdowns: In periods of economic hardship, the utilization of their facilities may decrease, leading to lower occupancy rates and lower overall revenues.

Given these risks, the company has some resilience: The healthcare industry is unlikely to disappear, while having different lines of business makes the company more robust.

Their services are necessary for the critically ill, leading to good demand.
They also have well-established brands with a strong presence that can attract new clients and partners.
They also have long-term partnerships with insurers and payors. The risks are quite large for the company, but the demand for their services, as well as the relationships they have, help balance these out.

Financials Deep Dive

Their financials aren’t straightforward as the company consists of four different and diverse segments. Here is how to understand it better.

Over the years, the company has improved its return on invested capital, and it’s operating margins while also growing its revenues. It means that the company has become more profitable and efficient.

Select Medical had revenues of $7.0 billion in 2023, compared to 6.9 billion in 2022. EBITDA in 2023 totaled $881.9 million vs $813.1 in 2022. Adjusted diluted earnings per share were $1.77 in 2023 vs 1.70 in 2022.

For full year 2023, Select Medical’s revenue breakdown was:

Critical illness recovery hospitals: $2.98 billion.
Rehabilitation hospitals: $1.59 billion.
Outpatient clinics: $1.28 billion.
Concentra: $1.14 billion.

Their long term plan is to grow revenue between 5% and 7%, and increase their margins by improving efficiencies in all divisions. They are expecting EPS to grow at higher rates of around 8% to 10% a year.

Their current ratio (ability to pay short-term liabilities) as of Dec 2023 was 1.43, which means they can cover current liabilities 1.4 times over. Total Debt to Equity was 107%, meaning they have slightly more debt than equity. Net Debt to adjusted EBITDA was about 3x which is not terrible, but it could be improved with a good capital plan, which they currently don’t have.

Looking at their historical returns, ROIC was around 13-15% in the last five years before 2022, and it has decreased to 11% in 2022 and is predicted to further drop in 2023 due to higher wages and expenses from inflation and supply chains. This shows that the returns have reduced as inflation ate into profits. They are working to reduce these costs, however, and aim for 15% or higher ROIC for future years.

In Q1 2024, Select Medical showed revenues growing to $1.8 billion, which represented a 7% year-over-year increase, and the net income was $17 million which is a massive drop of 78% from last year’s Q1 profit of $77 million. This was primarily attributed to an increase in expenses, with compensation and benefits increasing almost $100 million. They have also revised downward their outlook for 2024 due to these increased expenses. Their margins for 2024 are expected to be lower than what they saw in 2023. All these issues are temporary and management believes they will recover.

Understandability Analysis: 3/5

A rating of 3/5 is given for understandability. This is because while their business is not complicated, they have multiple divisions of their business, each working differently. This makes it a bit harder to follow than a single operation business.

The business model is relatively easy to understand as they provide healthcare services.
However, the different segments have different operations, which makes it difficult to understand all of them at the same time.
The business is dependent on government regulations and Medicare which makes it a little harder to understand.
Finally, their financials are relatively complicated due to the number of different types of business they operate, and therefore the value and risk calculations might not be as straightforward.

Balance Sheet Health: 3/5

A rating of 3/5 is given for balance sheet health. While the company doesn’t have any immediate solvency issues, their current financial condition is not optimal and could be improved.

The company has low amounts of cash compared to its size.
Their debt-to-equity is higher than we like which might limit their long term flexibility.
While the company’s cash flow is decent, the reduction of the ROIC in recent years will also reduce flexibility and profitability in the near term.
Their profitability is a good metric to have, and as they can use that to reinvest in the business or pay down debt, if it has high ROIC. This means, as they get ROIC back on track their financial health will quickly improve.

They have a solid amount of debt, which is not an advantage in the present market conditions. Their overall debt levels must be reduced.

Summary

Select Medical is a diversified healthcare services company that has some strengths, namely their high-quality brand, long history and a wide geographical footprint, as well as multiple segments which protect against regional issues. They also have relationships with some of the largest insurance and healthcare payors which means steady profits. However, they are facing labor shortages, inflation which hurts their profits, as well as increasing competition and regulatory pressures. Their moat is not a strong and is highly dependent on factors beyond their control, making future results less certain. They also have a balance sheet that has room for improvement and must reduce reliance on debt. For all these reasons the company might provide a good but not extraordinary return.