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Summary of investments

In the healthcare sector, there are many defensive offerings that provide equity portfolios with the opportunity to reduce equity beta and stabilize risk-adjusted returns. One such call is Addus HomeCare Corporation (NASDAQ: ADUS) with his resilience characteristics. Our findings indicate that ADUS delivers undeniable value, even as it makes substantial but necessary adjustments to its financial statements to reflect a more accurate snapshot. With a return on invested capital of 6.4% in the second quarter of FY22 and a WACC hurdle of 8.3% on an annualized basis, ADUS is the type of long-term cash compound we seek exposure to, and we advocate its inclusion in portfolios looking to scale up. the spectrum of quality and resilience. Ratings support defensive play with the added benefits listed above. With that in mind, we rate ADUS as a buy on a $96-$103 valuation.

Exhibit 1. ADUS course over 6 months

Stocks grabbed a bid in H2 FY22 amid a defensive turn in factors. In this vein, ADUS is looking to offer more upside capture as investors look to move up the quality spectrum.


Data: Refinitiv Eikon

Benefits of T2 – a deeper dive

Going beyond the standard GAAP reports, we extract interesting data for ADUS. The company reported an increase in revenue of about 870 basis points year-on-year to $237 million. Personal care contributed approximately 74% of revenue, while palliative care sales accounted for 22% of revenue. Geographically, ADUS’ turnover bolus [accounts receivable included] is obtained from federal and local government payers. Of that figure, the bulk of the revenue comes from Illinois, attributing nearly 44% to revenue in the last quarter, up about 490 bps year-on-year. Illinois’ biggest payer is the Illinois Department of Aging. It accounted for 20.7% of revenue in Q2 FY22, down around 200 bps year-on-year. However, receivables from this payer grew at a similar rate over the 12 months to reach 18.3% of revenue.

Meanwhile, same-store revenue in its home healthcare segment grew 21.6% year-on-year and 36% quarter-on-quarter. Revenue was $10.5 million in this division, ~4.5% of revenue. This was accompanied by a rising volume of admissions, which climbed 25% over the year. The average daily count (“ADC”) in its palliative care segment also improved with a median length of stay at 23 days compared to 17 days in Q2 FY21. The company also recorded an additional $55 million ($3.43/share) in revenue from its acquisition of JourneyCare, despite exceeding CMS’s proposed reimbursement changes.

Moving down the P&L, operating expenses of $58.7 million were up year over year, but included $3.6 million in depreciation and amortization. This brought that result down to an operating profit of $16.9 million and a net profit of $11.25 million, unchanged from last year’s result. ADUS also converted $56 million of FCF and investors are seeing a 7.7% return on that amount, compared to $16 million and 3.6% in Q2 FY21 respectively. These numbers are attractive at face value and signal a period of resilient growth for the company.

Metrics adjusted to reflect business value

A closer look at ADUS’ financial statements reveals that GAAP accounting understates the company’s reported earnings. This has implications for the valuation, for the profit part of the calculation. Adding $69.4 million of non-cash charges to COGS brings gross profit down to $145 million from $75.6 million printed. Additionally, SG&A fees were recorded at $55 million, and we estimate that 100% of this is likely to be “maintenance G&A” necessary for operations, not an investment. We could not see evidence to the contrary in 10-Q.

Adjusting non-cash operating expenses and adding stock-based compensation of $5.165 million lifts ADUS operating profit to $92.25 million, ahead of GAAP reported at about $17 million. This also has a profound impact on earnings, as following this reconciliation process, EPS rises to $4.05 and therefore presents an attractive value.

In addition, as shown in Appendix 3, ADUS has goodwill of over $574 million on the balance sheet, representing over 50% of total assets. Depending on how goodwill is valued, the treatment of goodwill in the case of ADUS has a huge impact on the valuation factors. Including it in the enterprise value calculation would see the equity value of ADUS at $599.7 million. However, the elimination of goodwill impairment [it isn’t amortized like other assets], shareholders’ equity slipped to $25 million. The question then arises to what extent, if any, this difference will be a problem.

Exhibit 2. Goodwill adjustment has a substantial difference in valuation results

The question then turns to what exactly are we buying here?


Data: HB Insights estimates

Appendix 3 covers the company’s accounting for its acquired assets and liabilities, the bolus being made up of goodwill. Again, goodwill is a non-cash asset that needs to be periodically tested for impairment, and therefore we wonder what future economic value of $70.77 million of undefinable value might be provided in these cases. We have chosen to omit goodwill from our valuation.

Exhibit 3. In the assets and liabilities acquired from ADUS, goodwill constitutes the bolus of “value”, ahead of identifiable intangible assets that can be amortized


Data: ADUS 10-Q Q2 FY22


The share price is approximately 2.5x enterprise value (“EV”) to the reported Q2 FY22 book value of $599 million. At this multiple, we would pay an implied price of $96.25, a premium that will need to be justified by the ADUS valuation profit stack. In terms of the investment stack, our post-adjustment production offers a paradoxical view – we would pay a steep discount, but only worth $25 million on the balance sheet. The question is whether one is willing to pay 25x the T12M earnings for this.

Alas, as seen in Exhibit 4, there could be compelling value on offer after adjustment. If we accept these adjustments, then the FCF adjusted return on equity is a staggering 542% for ADUS, and an equally impressive 211% for us as investors if we pay 2.5 times that book value. The implied payback period for FCF is less than 1 year at this level.

Table 4. Substantial differences in valuation according to the treatment of goodwill on the balance sheet


Data and image: HB Insights estimates

As for the valuation profit stack, the releases range from a price target of $89.55 to $103.85 based on forward estimates. We’ve pegged FY23 EPS estimates in the range of $2.93 to $3.63 for ADUS. As seen in the exhibits below, this produces the valuation range shown above. The arithmetic mean of these two values ​​is $96.52, which suggests that the stock price could also be fairly valued at this level based on the above analysis.

Exhibit 5. Valuation – profit stack


Data: HB Insights US Equity Fund


Data: HB Insights US Equity Fund

What we see here is the differential between the two EPS forecasts. Each suggests we pay a fair and reasonable price at ~2.5x EV/book value.

In effect, we implicitly pay $88.75 to $96.25 to receive a value of $89 to $103 (up 7-15% from the current market price). With that in mind, valuations favor further upside, even removing goodwill as a cleaner measure of tangible/intangible value.

In this vein, we rate ADUS as a buy and price the stock at $96-$103. We believe the company’s resilience premium will continue to shine and provide investors with a stabilizer of risk-adjusted returns in equity portfolios on the tactical allocation side.