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Go Crazy for Psychiatric Solutions

September 15, 2009 | About:
Psychiatric Solutions [NDQ:PSYS] Sep. 15, 2009 $29.30

52-week range: $12.49 (Mar. 6, 2009) - $40.90 (Sep. 19, 2008)

Psychiatric Solutions is the only publically traded, pure-play provider of inpatient behavioral health-care services. Its business segments include acute inpatient behavioral facilities, residential treatment centers (for long-term treatment), and a contract management business that provides psychiatric programs to hospitals and employers. The firm operates 95 owned or leased facilities with almost 11,000 beds in 32 states plus Puerto Rico and the U.S. Virgin Islands. They specialize in the treatment of children and adolescents. 2009 marked the fourth consecutive year that Psychiatric Solutions made Fortune magazine's list of the Top 100 Fastest-Growing Companies.

Profits per share have risen dramatically since 2003 through both organic growth and complementary acquisitions. Pending changes to the healthcare system will likely have mixed effects. More patients would likely be covered for their services but reimbursement rates might get squeezed a bit.

Here are the per share numbers as reported by Value Line:

Year ......... Sales ........ C/F ......... EPS ......... B/V ...... Avg. P/E

2003 ........ 24.60 ...... 1.21 ........ 0.73 ........ 7.65 ......... 7.2x

2004 ........ 23.80 ...... 1.31 ........ 0.97 ........11.95 ....... 12.8x

2005 ........ 13.88 ...... 0.80 ........ 0.59 ........10.29 ....... 39.6x

2006 ........ 19.22 ...... 1.54 ........ 1.14 ........11.75 ....... 28.2x

2007 ........ 26.89 ...... 1.98 ........ 1.40 ........13.70 ....... 26.9x

2008 ........ 31.57 ...... 2.65 ........ 1.92 ........15.91 ....... 17.5x

The dip in per share data from 2004 to 2005 reflects a share count increase from 20.47 million to 52.43 million to raise capital for expansion. This paid off handsomely with big increases in sales, cash flow and earnings in each year since. Profits were up 13.1% year over year in this year’s first half. Zacks now expects all-time record EPS of $2.31and $2.55 for 2009 and 2010 respectively.

That makes PSYS’s multiple just 12.7x this year’s and 11.5x 2010’s projections. Buyers of these shares in 2003 and 2004 (the last time valuations were this low) saw huge gains in their share values over the following three years.

A rebound to even 14x this year’s earnings leads me to a minimum target of over $32 /share by the time full year results have been released. That’s in line with Standard & Poors’ $32.80 ‘fair value’ estimate.

The need for behavioral health treatments appears to be growing and PSYS seems well situated to benefit from the trend. Here is a buy/write combination that offers good total returns with moderate risk…

........................................................ Cash Outlay ................. Cash Inflow

Buy 1000 PSYS @ $29.30 /share ............ $29,300

Sell 10 Mar. $30 calls @ $3.50 /share ........................................... $3,500

Sell 10 Mar. $30 puts @ $4.00 /share .......................................... $4,000

Net Cash Out-of-Pocket ......................... $21,800


If Psychiatric Solutions just inches up at least 2.4% to > $30 by Mar. 19, 2010:

• The $30 calls will be exercised.

• You will sell your shares for $30,000.

• The $30 puts will expire worthless.

• You will have no further option obligations.

• You will end up with no shares and $30,000 in cash.

That’s a net profit of $8,200/$21,800 = 37.6%

achieved in just over 6 months on shares that only needed to rise by 2.4%.


What’s the risk?


If Psychiatric Solutions finishes < $30 on Mar. 19, 2010:

• The $30 calls will expire worthless.

• The $30 puts will be exercised.

• You will be forced to buy another 1000 PSYS shares.

• You will need to lay out an additional $30,000 in cash.

• You will have no further option obligations.

• You will end up with 2000 PSYS shares.


What’s the break-even on the whole trade?

On the original 1000 shares it’s their $29.30 purchase price less

the $3.50 /share call premium = $25.80 /share.

On the ‘put’ shares it’s the $30 strike price less the

$4.00 /share put premium = $26.00 /share.

You overall break-even would be $25.90 /share.

PSYS shares could drop by up to $3.40 or (-11.6%) without causing a loss on this trade.


Summary:

If the market is driving you crazy this may be the play for you. A small gain of less than 3% in these reasonably priced shares translates to a better than 37% cash-on-cash return if PSYS finishes above $30 on expiration date.

You have a margin of safety of over 11% before a loss would occur.

Disclosure: Author is currently short PSYS puts.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.TalkMarkets.com

Visit Dr. Paul Price's Website


Rating: 5.0/5 (2 votes)

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