Business Breakdowns
· Zack Fuss, Chadd Garcia
[00:00:00] S0: And so how do you win market share? Presumably, they don't have a monopoly in the regions with which they operate. There's patients that are coming into hospice programs on a daily basis. Can you explain how that works? [00:00:00] S1: You have sales representatives that go into hospitals that talk to patients, that talk to families. You have sales representatives that go into assisted living facilities that talk to patients and talk to families. This business was very similar to Roto-Rooter. When going from 2012 to COVID, there were hardly any quarters where they had negative growth. And the ones that they did have were more of a payment timing issue related to the 2013 budget sequestration. But when COVID hit, hospitals shut down letting outside people in, and so did assisted living facilities. And so their ability to market at that point was impaired. Hence the negative comps they experienced in the early days of COVID. It's blocking and tackling, boots-on-the-ground salesforce. [00:00:00] S0: Much like Roto-Rooter, is it fair to say that this is mostly just a business that kind of allocates labor? Presumably they don't have centers that they operate. There are staff members that they send to provide care.
· Zack Fuss, Chadd Garcia
[00:00:00] S0: Much like Roto-Rooter, is it fair to say that this is mostly just a business that kind of allocates labor? Presumably they don't have centers that they operate. There are staff members that they send to provide care. [00:00:00] S1: They do have inpatient care, but that's like 1% of the service. 99% would be in a person's home. But if a patient's needs can't be managed at home, they do have inpatient care. So you do have those assets. To your point, it is much less than managing the labor component of it. One way to get market share is you take advantage of industry disruption. The government sets the reimbursement rate and they do it once a year. And it's based to some extent on inflation. When COVID hit, there was massive inflation within the healthcare sector and it was difficult to get nurses. And so you saw them invest in VITAS. They put $37 million into retention bonuses for their nurses, and then they spent another $3 million recruiting new nurses to come into their program, which set them up really well to take market share once the hospitals and assisted living facilities reopened. And if you look at the results of that, they had negative comps from Q4 of 2020 through Q4 of 2022, and then they had 2 quarters of single-digit comps and then spent double digits, low to high teens, ever since. VITAS can be in a position to take market share when there's a disruption in an industry such as high inflation and a government that may be a little bit slow to increase the reimbursement rate during extraordinary times.
· Zack Fuss
[00:00:00] S0: Bringing it all home. At the onset of this conversation, we elaborated on the capital allocation prowess of the business. In their corporate presentations, they also suggest that there's a willingness to split these two businesses up. Interestingly, the business runs in a net cash position. They're aggressive in their buybacks at times when the stock is dislocated. What is their philosophy around allocating the incremental dollar? Why do they run their balance sheet so conservatively? And at what point would it make sense for these businesses no longer to coexist?
· Chadd Garcia
[00:00:00] S1: Go back to the philosophy of the management team. Their job is to grow the free cash flow per share. And I think that Roto-Rooter is a great business. It's got a little bit of challenge recently, but I think they're very happy running it. I think they're going to work through those challenges. And so the only reason why they would sell it is that somebody offered them a price that was too good to pass up. Other than that, then why sell it? With respect to VITAS, I don't think we'll know the answer anytime soon. But it will be interesting to see how this industry continues to consolidate. Is it going to consolidate where independent entities like VITAS become the dominant players? I think that makes sense because of how the reimbursement structure is. That makes sense to me that you want a portfolio. Or does it make sense that you want this business partnered with another healthcare provider like an assisted living facility or a hospital? If that turns out to be the case, then I could see Chemed acquiring some other healthcare businesses to partner with VITAS, or I can see them just selling VITAS at that point. That would make sense to sell. If the independents aren't going to be the dominant players in the business. Another reason for them to split the two businesses would just be if this ever trades at a protracted holdco discount, and I don't think that's the case. It could be a little more richly priced than it is today and the management team is going to deal with that by buying back stock. But if this ever traded at a substantial holdco discount, then I would see them buy, sell, spin, separate the two businesses.
· Zack Fuss
[00:00:00] S0: When you kind of reflect upon your study of this business and the story of its composition and evolution, what are the lessons you take away from it and apply to other aspects of your investments?
· Chadd Garcia
[00:00:00] S1: Well, from an operational standpoint, them choosing at VITAS to be in certain markets that allows them to have margins that are top of the industry provides that business with an ample amount of protection. One of my core theses on this business is that it saves the government an ample amount of money and the government should want to support it over the long term. Over the short run, the government can act a bit irrationally and we've seen that in how slow they were to adjust the reimbursement rates in COVID. But VITAS' margin structure being 2, 3, 4 times higher than that of the bottom half of the industry provided them with ample margin of safety and the ability to take advantage of those short-term disruptions. From a capital allocation standpoint, it's often very hard to determine if a management team ex ante is going to be a good capital allocator. But I think it helps if structurally there's just a business that's set up to do it. So if you look at these two businesses. Both of them generate an ample amount of cash and they require very little to go back into it. Yes, there are opportunities to acquire franchises, but for the most part, it's small. At Roto-Rooter, yes, recently there was an opportunity to do an $85 million acquisition at VITAS. But maybe they get another one or two of those. I don't think they're gonna get too many. They're able to compound their earnings growth at a high rate and have an ample amount of cash. And then how do you manage that cash? You can do a programmatic buyback. You might see Ecolab or AutoZone, or you can just let the business build cash. And when the stock price drops below its intrinsic value, you step in in size, which is what this team has tended to do over time. I think because of their philosophy of growing their free cash flow as their reasons for existence and the minimal capital needs of the business. He could have seen a decade ago that these guys are going to be great capital allocators. And I think you can get comfortable that they'll continue to be.