AHCO - AdaptHealth: Tough In The Near-Term But FY25 Targets Remain Intact

2023-04-05 18:59:08 ET

Summary

• AHCO is a promising long-term investment due to the expected growth in the HME market, driven by demographic shifts and the rise of chronic diseases, as well as potential M&A.
• AHCO reported a 4Q22 miss, with revenue and EBITDA falling short of both consensus estimates and management guidance ranges.
• Management has taken a cautious approach by lowering their FY23 guidance ranges to account for ongoing challenges.

Overview

My original thesis was that AdaptHealth ( AHCO ) would be a good investment because of the HME market, which is expected to grow to $62.1 billion by 2030. Because of demographic shifts and the rise of chronic diseases, there is a greater demand for service providers like AHCO to bring medical equipment to patients' homes. Unfortunately, short-term results have been dismal. To put this in perspective, on January 10th, AHCO preannounced 4Q EBITDA results and consensus subsequently adjusted their estimates for the year and 4Q22. However, 4Q22 adjusted EBITDA came in at $146 million, which was significantly below market expectations. Considering that new guidance came out only a little over a month ago, I find this hard to believe. This has certainly caused the 2nd nosedive in stock price. However, management is confident in the long-term guidance ranges it provided at the investor day in September 2022 , despite the fact that volume challenges in some product categories and persistent high inflation have dampened earnings trends in the near term. Management anticipates growth to re-accelerate, which would lead to AHCO's revenues increasing to $4 billion in 2025 and generating $300 million in free cash flow. I acknowledge that these targets are hard to underwrite at the moment, and it is a "show me" story. However, I believe that secular tailwinds in CPAP and diabetes, as well as likely M&A, are reasons to be optimistic about its ability to deliver on longer-term revenue and earnings targets. Because of this, I'm keeping my "buy" recommendation.

Build up to the 4Q22 miss

The $780 million in revenue that AHCO reported for the fourth quarter of 2022 fell short of both the consensus estimate of $788 million and the management guidance range of $760 million to $820 million. Also, the $146 million in EBITDA was below both the $178 million expected and the $172 million to $202 million guided by management. It's worth noting that just a month ago, management had predicted that Q4 results would be on the low end of their projection ranges. Therefore, the reported miss was still disappointing, even when measured against more reasonable expectations. The management team explained the shortfall as a result of difficulties in recovering certain receivables, higher-than-anticipated distribution costs, and higher-than-anticipated labor costs.

Guidance was further cut

Management has taken a cautious approach in light of the 4Q22 miss and recent trends by lowering their FY23 guidance ranges to account for the ongoing impact of some of the challenges encountered in the prior quarter. I think the fundamentals and performance may be weaker than expected, which is why I believe this guide down is more than just being conservative. Notably, AHCO's management decided to lower revenue and EBITDA expectations due to continued relative softness in business lines other than sleep and diabetes as well as continuing inflationary pressures. Note that the underlying cause is inflationary pressures, which clearly is not moderating as much as politicians and investors want. The IMF has put out a case that inflation could persist much higher and longer than expected, and while I cannot say for certain this would be the case, the uncertainty it brings is not healthy for the stock. Aside from this, even good things have their limits: despite continued strong demand, AHCO has been unable to fully capitalize on its strong order flow and the remainder of its order backlog accumulated over the past couple of years due to supply constraints. In my opinion, short-term performance would be weak, but the built-up backlog would give reason to be optimistic about the outlook for growth in the medium term.

Bear case

I believe the main bear case will revolve around issues like over reimbursement on CGM from Medicaid. The charges in 4Q22 only add fuel to the fire, despite management's denials. I think this could spark a more bearish narrative if AR write-downs keep happening. Despite a decrease from 20% in December of last year, short interest in ACHO is still quite high at 12.84% of float. This observation has two sides:

1. Bears continue to have a strong belief that there is still downside to the stock, especially with all the headwinds and uncertainties mentioned above
2. Once bears are proven to be wrong, there could be a surge of purchases (from shorts covering their position), which will drive the stock price upwards

As of now, it is still unclear who is right.

Conclusion

In conclusion, while the short-term performance of AHCO has been disappointing, the long-term outlook remains promising due to secular tailwinds in CPAP and diabetes, as well as the potential for M&A. The recent guidance cut by management reflects ongoing challenges in some business lines and continuing inflationary pressures. However, I believe if AHCO can eventually hit its FY25 target (which I think it can once we get past FY23), all these short-term fluctuations would not be important in hindsight. Overall, given the potential for significant upside once the uncertainty surrounding the stock is cleared, I maintain my "buy" recommendation on AHCO.

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