Business Breakdowns
· Chadd Garcia
[00:00:00] S1: Good to be with you. So, yes, Chemed, old people, old houses. As my friend once told me when he started looking at it. I call it the HEICO of the Midwest, though. If you know HEICO, when you listen to Laurans Mendelson, the CEO, he says, you know, we're not in the aerospace business. We're not in the defense business. We're in the business of growing free cash flow per share. And the first time I talked to the Chemed management team in 2020, they said our business is to grow our free cash flow per share, and we're agnostic on how we do it. We have two businesses right now, and if somebody gave us a great price for either of them, we may exit it. And if a great business come along, we may get into that, too. We grow our free cash flow per share. The more I dug into that, the more evidence I saw that they lived by that value. And I wondered why they weren't in the first edition of the Outsiders. Because, you know, it's definitely a business that has done well managing their operations and has had fantastic capital allocation. The only reason why it probably wasn't in it is because nobody knows about it. I mean, there was maybe one to three analysts at any given time that has covered the company, maybe two analysts that covered it. In 2020, they reported their first quarter earnings and there was one analyst on the call. Still today, not too many people know about it. Let's get into the history of it. The business was formed in the early 1970s when it was spun out from W.R. Grace, which was a chemical company. Grace spun out a specialty chemicals business. So that's the chem part of Chemed. And they spun out Omnicare, which is a pharmacy services business. That business, maybe a decade ago was bought by CVS. So that's the med part of Chemed. In the 1980s, they had a couple large corporate transactions. The first one was they bought Roto-Rooter, the plumbing services business. And then a year later, they spun out Omnicare. And so that left Roto-Rooter and their namesake specialty chemicals business. Fast forward a couple years to the 1990s, they had a couple more large transactions. The first one was that a company approached them to acquire their chemicals business. I think they were very happy with their business and they were happy to own it and grow it, but the price was too good for them to pass up.
· Chadd Garcia
And so they sold their namesake specialty chemicals business. That gave them a pile of cash. They ended up financing a private equity player's purchase of VITAS. They put some convertible debt into VITAS to finance the transaction that gave them a 20% stake in the business. Over time, that position grew to be 37% in the business. Fast forward to 2003. The sponsor came to them and said, get ready. We're about ready to sell the business. And Chemed's management asked the sponsor what their price expectations were. And they gave him a price. And they're like, well, we're not sellers for that price. We're buyers. And so they ended up buying the remaining stake of VITAS. And since 2004, they've held Roto-Rooter and VITAS, and they've grown them both. Both of them grew organically. And then with respect to Roto-Rooter, they put some money into acquisitions to acquire some of the franchises. That business has some franchises outstanding, so they've been acquiring their franchises. VITAS, they mostly grew via greenfield. With the exception of last year. They were able to do an $85 million acquisition, but for the most part, they didn't do any acquisitions. The business generates ample free cash flow. Both these businesses have high returns on capital. Corporate pays a very small but de minimis dividend. And they do it for a couple reasons. Some investors require a dividend in order to own a company. Other investors require that that dividend be growing in order to start a position in the company. And so they pay a de minimis but growing dividend in order to check those two boxes. And so if you look at the amount of free cash flow the company generated since 2004, they generated around 3.7 billion. That's net of 600, 700, $800 million worth of capital expenditures throughout that time. They've spent about $700 million on acquisitions. They paid $300 million on dividends, and they've bought back $2.5 billion worth of stock. So they've taken their share count down from 25 million in '04 to 15 million today.
· Zack Fuss
[00:00:00] S0: A share cannibal with adept capital allocation, as you alluded to. I want to dig into the actual businesses. So today, the enterprise itself sports a valuation of around $8 billion, revenue approaching two and a half billion, and $500 to $600 million of EBITDA. Can you just break that down between the two businesses and then we can dig into the qualitative and quantitative characteristics of both of those businesses and what exactly they do?
· Chadd Garcia
[00:00:00] S1: Roto-Rooter is now the smaller of the two businesses, probably 30, 35% of the earnings. It was founded by a man named Sam Blanc in the 1930s. Sam invented a drain-cleaning piece of equipment by taking a Maytag washing machine motor and attaching a cable to it with some blades. And that allowed for the cleaning of drains. Prior to that, if a drain was severely plugged, it required to be excavated and oftentimes the pipes replaced. And so that was a new technology. In order to grow the technology, Sam set up a lot of franchises which gave people exclusive rights to operate within a given area. Fast forward to today, the company has three business lines. One would be company-owned branches. You'll find these in very large metropolitan areas. That's where Roto-Rooter the company has the right to operate in a large metro area. They'll own the business that does all the plumbing services within that area. There are franchisees, as we discussed. In this business, the franchisee owns the rights to the Roto-Rooter name within a certain geographic area. They pay Roto-Rooter a small fee, but they receive almost no support from corporate. Roto-Rooter figured out that they can run these plumbing businesses a lot better than a lot of the franchisees because they have the benefits of scale with respect to the back office. They also are better at marketing and doing search-engine optimization and other marketing functions. And so they want to acquire as much of these as possible. If they acquire a franchise that serves a large metro area, they're likely to turn that into a branch and operate the business themselves. If they think that the business, the area that serves is a little too small. So think about a mid-market area or a rural area. They will partner with an independent contractor to operate the business and provide the plumbing services. With respect to their independent contractors, Roto-Rooter is very hands-on with respect to providing back-office support and providing a lot of marketing support, but their partner provides the actual plumbing services. This is closer to a franchise model that we would see like in a restaurant or other businesses. For the benefit of being an independent contractor to Roto-Rooter, you get the benefit of all the back-office help and the marketing help and then you pay them a 28% royalty fee.
· Zack Fuss
[00:00:00] S0: We'll come back to kind of the ebbs and flows of Roto-Rooter's businesses and its different services, but how about a similar overview of kind of the VITAS business and how it came to be?
· Chadd Garcia
[00:00:00] S1: One quick note. If you look at Roto-Rooter's history, they have grown their revenue about 6% clip. That's about standard for them in a 2-3% normal inflation environment. And then because they've been expanding their margins, they have about 25% EBITDA margins. But because their margins have been expanding, their earnings growth has grown about 12%. VITAS. We'll get into that business, but it has about the same profile with respect to low-mid single-digit revenue growth, low double-digit earnings growth. And then when you combine it at a corporate level and you layer in all the share repurchases they have, their EPS grows about 20-21% and their stock price over the last 21 years has compounded about the same rate. VITAS is a hospice and palliative care provider. What hospice care does is it provides health care to patients who are in their final days of their life. When you're in your final days, you have a couple courses of action with respect to healthcare. You can continue to try to receive curative care, which is quite expensive and oftentimes ineffective. It may actually do more harm than good. Or you can opt for palliative care which aims to manage your pain and make it more comfortable on your final days. VITAS provides that and it's provided 99% of all the care is provided in a patient's home. If you're in your final days, one can imagine that it would be more comfortable for you to be in your own house as opposed to a hospital. Hospice providers enable that to happen.