INNV - InnovAge Holding: EBITDA In Focus With No More Sanctions

2023-06-26 23:13:05 ET

Summary

• I reiterate a buy recommendation for INNV, expecting continued growth due to its focus on the complex healthcare system and an aging population.
• The lifting of sanctions against the Sacramento facility has expanded INNV's capacity, and investments in de novo openings and a new COO position the company for future growth and market expansion.
• Management's efforts to enhance operational efficiencies and implement EPIC are expected to drive sustained profitability and margin improvement.

Thesis update

I reiterate my buy recommendation for InnovAge Holding ( INNV ). Recapping my previous thesis, I think INNV has found its footing by focusing on the most convoluted part of the healthcare system. With an aging population ahead, I believe INNV will continue to grow. Now that the sanction seems to have been lifted and there is a clear path to increased margins, I believe the stock will start to benefit from positive narratives.

Capacity

On May 1st, the final enrollment freeze sanctions against the company's Sacramento facility were lifted , marking the official end of the sanction story. With this, INNV's capacity has grown, allowing it to boost utilization even further. To put this into perspective, there is significant room for capacity absorption at the Sacramento facility center, which currently has around 130 patients but capacity of around 1,500. As was the case with the previous sanctioned facility in Colorado, I anticipate a steep rise in utilization rates over the next few months. Positive momentum in April and May and good progress toward internal targets were cited by management as reasons for optimism about Colorado's enrollment drive, which should reach pre-recession levels by 1FQ24.

The benefits of management's continued investments to expand capacity are becoming apparent. The de novo openings in Tampa and Orlando, should begin contributing in FY24, creating favorable conditions for easy comps growth. On the point of markets expansion, INNV recently named Christine Bent as Chief Operating Officer. The fact that Bent will now manage current PACE centers and launch brand new programs in untapped markets gives me more hope for the future growth prospect. I think INNV can benefit from Bent's wealth of experience because the company's current expansion plans require it to penetrate new markets. This strong operational expertise may prove invaluable as the company moves forward with the two Florida facilities. Based on management's comments, both the Tampa and Orlando locations should be ready to open in FY23 as they are making good progress on the application process and other milestones, and these developments are on schedule with internal expectations objectives. Long-term, I think INNV can grow into additional states like Indiana, Kentucky, Ohio, and Texas; however, this growth should occur only after INNV has established itself firmly in its current markets.

Margins

I continue my positive outlook for INNV margin as management remains focused to enhancing operational efficiencies which I expect to result in sustained profitability and growth over the long term. For instance, the consolidation of local assets with proximity to each other in order to drive operating leverage from labor and capacity fixed cost. Additionally, by the end of the year, all INNV facilities will have implemented EPIC, which should provide additional support for operational efficiency. More than half of INNV facilities have installed the EPIC system, and its rollout in Colorado is expected to begin within the next couple of months. However, as G&A is accelerated in preparation for the launch of the Epic EMR, I anticipate some margin headwind in the medium term due to cost of implementation (not a problem as revenue scales).

Another thing I would note is that, previously, the decision-making process is designed to ensure sustainable compliance model, but not is changing to deploying new initiatives to improve unit economics. Thus, I believe there is further room for INNV margin to improve, and that historical margin might not be the best benchmark for future margin profile as the business was not optimized to drive best-in-class unit economics. It was instead optimized to err on the side of caution, leading me to believe that there are numerous extraneous costs that could be eliminated. Wage is one area where I anticipate savings, as I believe that G&A expenses in the past have trended upward as management has invested in more people to ensure compliance with sanctions.

Valuation

Given the improved outlook for growth and margin expansion, I believe INNV should trade at a higher multiple than it has been. When compared to peers such as SEM, BKD, EHC, SGRY, and USPH, where the average EV to forward revenue multiple is 2.3x today, I believe INNV valuation has plenty of room to improve. However, a discount is still warranted today because INNV is still losing money. I believe INNV should trade above its recent high of 1.4x, so I modelled 1.5x (anything above this would be fantastic). Using consensus estimates for FY25, this implies a potential 30% increase by FYE24.

Risks

PACE has been available for about 30 years, but only a small percentage of Medicare and Medicaid recipients take advantage of it. This gives me pause about the program's long-term viability and ability to grow and attract new members. Lack of action from the major insurers may also be causing hesitation throughout the healthcare system.

Conclusion

I maintain my buy recommendation for INNV. With a focus on the complex part of the healthcare system and an aging population ahead, I anticipate continued growth for INNV. The lifting of sanctions against the Sacramento facility has expanded INNV's capacity, allowing for increased utilization rates. The company's investments in de novo openings and the appointment of a new Chief Operating Officer position it for future growth and market expansion. Management's efforts to enhance operational efficiencies and implement EPIC are also expected to drive sustained profitability and margin improvement.

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