Aches, pains and partnerships. That’s the story of U.S. Physical Therapy (USPH, Financial). Aches and pains, not to mention recovery after surgery, represent a growing market as the population ages, and younger generations hit the tennis courts and running tracks.
Partnerships refers to the business model of U.S. Physical Therapy, Inc. which has found a growing and profitable niche working with local therapists. This 25-year old company now has interests in some 500 clinics (491 in August 2014, according to an investor presentation), and a market cap of $437-million.
Not that you will see the company’s name and logo atop many buildings or storefronts. It focuses on local identity, not the corporate logo.
USPH comes to our attention thanks to its high position on the GuruFocus Undervalued Predictable screener.
A high position on this list indicates the current stock price is below the Discount Cash Flow valuation, and the high predictability rating means the company has consistently improved its revenues and/or earnings. More on this later.
The business
U.S. Physical Therapy operates clinics that provide pre- and post-operative care for: orthopedic-related disorders, sports-related injuries, rehabilitation of injured workers and preventative care.
About two-thirds of its clinics are startups, built in partnership with local practitioners (many startups are satellites of existing clinics).
The other third of its clinics result from strategic acquisitions, with "significant ownership" still held by the clinics’ founders.
The company is incorporated in Nevada, while its head office is in Houston, Texas.
Takeaways: This company is an aggregator, mostly of "Mom & Pop" physical therapy clinics. Going public has given USPH access to financing for acquisitions and what it calls "de novo" (fresh start) additions.
Where the revenues come from
The following excerpt from the 10-K Report for 2013 shows the sources of revenue for fiscal 2013 (in thousands of dollars):
Medicare plays an important part in revenue generation, 21.7% of net patient revenues in 2013. While there are some positives to government billables, there are also a couple of downsides. In his 2013 Letter to Shareholders, CEO Chris Reading notes, "Continued partisanship in Washington made its way into the budget fray and ended up creating an easy, albeit not-too-sensible, reduction in spending which impacted our industry in what we refer to as "MPPR" or Multiple Procedure Payment Reduction. The MPPR reduction was both unnecessary and unexpected. That reduction, coupled with the "sequester" spending reduction, became effective in April 2013 and impacted our Company by an estimated 22-cent reduction in earnings per share in the last three quarters of 2013.
Takeaways: A reasonable mix of payers, which means collections should not be a problem. However, Medicare remains a mixed bag of advantages and disadvantages.
Growth and ownership
Think owner-operators in trying to position USPH’s partnership approach. It starts by seeking out local practitioners who already have relationships with physicians and others who might refer patients. Some buys involve single-clinic locations, while others involve multiple locations. About 60% of clinics start from scratch (or "de novo," as the company calls them in its communication).
In 2013, the company reports it spent some $50 million on acquisitions.
Once partnerships are established, the company works with the local practitioner to open new satellite clinics in the area, and sometimes it develops these new clinics on its own.
Benefits to partners, the local practitioners, are summarized this way in the Investor Presentation:
The company summarizes its growth strategy this way in the following excerpt from its Investor Presentation:
Dividend payments will not affect the company’s growth, according to the Investor Presentation.
U.S. Physical Therapy operates within a highly fragmented industry, made up of many small players and a few big players. It believes itself to be the third-largest player in the industry, with 491 clinics in August 2014. It puts Select Medical first with 1,017 clinics, and Physiotherapy Associates second with 590. It also believes no company in the industry has more than a 6% market share.
Marketing focuses on the physician community, and particularly on orthopedic surgeons, neurosurgeons, physiatrists (nerve, muscle and bone experts), internal medicine physicians, podiatrists, occupational medicine physicians and general practitioners, according to the 10-K report. Corporate specialists work with clinic directors to develop and execute marketing plans, which emphasize quality medical care and regular communication about patient progress. In addition, the company works with clinics to develop key relationships with HMOs, preferred provider organizations, industry and case managers, and insurance companies.
The company says the market is currently worth more than $15 billion and will grow at 3% to 4% a year.
Takeaways: USPH has successfully used this growth and marketing model for a number of years. Given its cash flow and earnings, it will be able to afford to continue its new clinic/acquisitions strategy.
Management
Chairman of the Board: Jerald L. Pullins has been a director since 2003 and chairman since 2011. Since 2007 he has been the managing member of SeniorCare Homes, LLC, which develops, owns and operates residential homes for senior citizens with Alzheimer's, dementia and other memory impairment conditions.
CEO: Christopher J. Reading, who joined the company as chief operating officer in 2003. He previously served in management positions at HealthSouth Corporation and has a B.S. in physical therapy.
CFO: Lawrance W. McAfee also joined USPH in 2003; he also serves as executive vice president and a director.
COO: Glenn McDowell joined the company in 2003, also worked at HealthSouth Corporation, and has B.S. and master's degrees in physical therapy.
Board of Directors: includes expertise and experience in health care, management consulting, venture capital, and physical therapy (management and board info from the company's website).
The ISS Governance QuickScore Summary gives U.S. Physical Therapy a rating of 5/10. On this scale, 10/10 is a poor score and 1/10 is a good score, so the company is rated medium. It receives two red flags, for Voting Formalities and Equity Risk Mitigation.
Takeaways: Senior management with knowledge of physical therapy, and long tenures at the company. The board appears to have the right kinds of experience and expertise for growing this company.
Ownership
Two gurus followed by GuruFocus have positions in U.S. Physical Therapy; Chuck Royce (Trades, Portfolio) has 1.456-million shares, and Jim Simons (Trades, Portfolio) has 635-thousand shares. According to nasdaq.com, Royce & Associates LLC is the largest single owner of USPH shares.
Institutional ownership: 91% according to nasdaq.com, which also reports 116 institutional holders with 11,115,879 shares altogether (that’s slightly more than the number of shares in the float).
Short interests: GuruFocus puts this at 2.8%, a low level of holdings, and graphically shows this interest in historical context:
Insiders: hold 6% of the outstanding shares, and according to Yahoo! Finance, CEO Christopher Reading holds the biggest single position, with 135,000 shares, while Director Daniel Arnold owns 126,000 shares.
Takeaways: For a small cap, this company has serious investors behind it, including two gurus and a lengthy list of institutional investors. Insiders own more than the shorts, another reassuring sign.
USPH by the Numbers
Takeaways: A couple of points worth noting: the current share price sits reasonably close to its 52-week high, the company does not repurchase shares, but does pay a modest dividend and still has enough funding to continue organic growth and acquisitions.
Financial strength
GuruFocus rates U.S. Physical Therapy as a 9/10 for Financial Strength and 8/10 for Profitability & Growth, both very good metrics:
USPH’s Debt to Equity ratio has bounced around since the financial crisis a few years ago. The following graphic shows that fluctuation (green line), along with the median Debt/Equity ratio of the Health Care Provider industry as a whole (blue line):
As the chart shows, USPH has stayed well below the median of its industry. In any case, given the low cost of borrowed funds (and its ROE of more than 18%) and the relatively low D/E ratio, borrowing to grow the business would make sense.
The company also looks good when compared to its peers on the Price-to-Free-Cash-Flow Ratio (green line shows USPH, blue line shows its peers):
GuruFocus notes that USPH ranks higher than 97% of companies in the Global Health Care Industry.
Takeaways: Modest debt and strong free cash flow metrics suggest this company should be able to continue its rapid growth in coming years.
Valuations
At the beginning of this article, we noted that USPH has a high place on the Undervalued Predictable screener because of the high Discount Cash Flow reading:
More specifically, the stock is trading 64% below its intrinsic price of $100.00. For the rationale behind this, see the Undervalued Predictable results page (you may also have to click on the text that says, "Click to Show/Hide").
U.S. Physical Therapy is also a predictable stock, with a 4.5-Star rating. Backtesting by GuruFocus found that stocks with a 4.5-Star rating averaged gains of 10.6% a year over 10 years. In addition, the backtesting found only 10% of 4.5-Star stocks were still in a loss position if held for 10 years. The following chart shows what’s behind this type of performance (green line for price, blue line for EBITDA):
Takeaways: Based on these factors, the stock is underpriced. Whether (or when) USPH hits $100 or not, the stock price should continue to go up. With a proven growth strategy and ability to turn that growth into earnings the stock price should follow.
Opportunities and risks
An aging population, as well as large active and obese populations, combine for a growing physical therapy market, one that the company expects will grow by 3%-4% a year.
Health care organizations seek faster recoveries to reduce their costs and look to physical therapy as a tool to achieve that goal.
16,000 different clinics in the U.S.A., most single location facilities, provide opportunities for aggregator like USPH.
The company has put together a package of benefits, including profit sharing, that allows practitioners to focus on professional work and leave administration to professionals.
It works to differentiate itself from competitors by locating in ground floor offices with nearby parking to be as accessible as possible to patients.
A proprietary program called FIT2WRK has helped the company brand itself and win contracts with major employers such as Chrysler and Dow Chemical.
Turning to risks, we seek that almost 22% of revenues come from Medicare. Fees may be cut for economic or political reasons; such changes shouldn’t affect the company’s viability, but may lead to short- or medium-term revenue reductions.
Governments at the federal, state and local levels all have a say in regulating the practice of physical therapy, and new regulations or enforcement procedures may hamper the company’s performance.
Complying with a myriad of existing regulations is an ongoing challenge (for more on opportunities and risks, see the USPH Investor Presentation and 10-K Report for 2013).
Outlook
While U.S. Physical Therapy finds itself challenged by issues such as Medicare fees and funding, there seem to be no reasons why it cannot continue to grow both its top and bottom line.
It has a successful business model, good management, sufficient internally-generated financing, and a relatively untapped market for aggregation.
Conclusion
U.S. Physical Therapy is a small cap stock that generates predictable returns like a large-cap.
As we’ve seen, it has consistently grown revenues and earnings, using its partnership model, a model that combines local presence with national buying and administrative power.
With a modest forward dividend of 1.4% it will pay something while the value of the company grows.
It deserves the due diligence of investors looking for long-term capital appreciation with a "starter" dividend.
