INNV - InnovAge Holding: Time To Go Long

Summary

• The lifting of sanctions has created a positive outlook for the stock and its future profitability.
• INNV is focusing on expanding its largest market share in Colorado as enrollment is set to begin in March.
• INNV has made progress in improving operations and reducing expenses, which should lead to a return of margins to pre-sanction levels.

Thesis update

The time to buy InnovAge Holding ( INNV ) is now, in my opinion. In line with my original post , 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 is benefiting from positive narratives as well.

Key highlights

Now that sanctions have been lifted in Colorado, the attention is on how quickly they can increase census operations in their largest market, which accounts for a sizable portion of INNV total market and its earnings potential. EBITDA for the quarter was significantly higher than expected and up q/q despite lower revenue, and it gives a margin baseline before the census rebuild. Important takeaways include INNV's recognition of capacity at existing facilities and the company's ability to leverage fixed costs, both of which point to a future emphasis on expanding margins. The timing of when INNV will resume its previous margin profile is an important open question.

Sanctions

Sanctions uncertainty was a major factor in my decision not to invest in INNV. As a result of the lifting of sanctions at its Colorado facilities in January, INNV is now anticipating the start of enrollment to occur in March. With this, INNV can start absorbing excess capacity in its biggest market, which accounts for about 44% of the total census. There will be little to no increase in infrastructure costs to accommodate the roughly 1,900 additional patients in Colorado, which should have a positive effect on profit margins. As for the facility in Sacramento I expect a similar result to follow soon if all goes well - which would certainly help with earnings. In addition, the company's de novo plans, which have been on hold for over a year due to the sanctions, will finally begin to be implemented. In the coming quarters, two new facilities in Florida with a combined capacity of 2,600 are expected to open.

Fundamentals

It is encouraging to see that INNV is still committed to making the sorts of operational improvements that will, hopefully, lead to sustainable despite the sanctions that have been imposed. Management claims that early improvements in participant satisfaction and productivity are a direct result of their progress toward completing the first round of initiatives announced to address audit deficiencies. One thing to note is, additional capacity for over 3,000 patients has been made possible by INNV's decision to increase headcount in sanctioned centers in response to audit findings and in anticipation of the lifting of enrollment freezes - as such we should see strong incremental margin from here. When it comes to the bottom line per unit, INNV has already begun introducing measures to boost service quality while cutting costs. Generally speaking, it appears that INNV has made progress in enhancing operations, which has resulted in cost savings.

Margins

A key takeaway from these financials is that management anticipates operating leverage once growth picks back up. For instance, this quarter margin improvement was also due to operating leverage. Management cited several factors as reasons for optimism about the future of the company's profit margins, such as the general health of the population improving as new patients are added to the overall population, labor productivity, loose labor market and lower inflation headwinds, more accurate risk coding, and improved discussions with payers. That said, as INNV is still ramping up growth back to previous levels, the impact from incremental margin will not be fully felt in the near-term. Margin should slowly improve over the near-term. Over the mid to longer-term (FY24/25) we should see the full impact, and margins should return to previous high.

Guidance

Although INNV did not offer specific guidance, it did shed light on trends moving forward. Management anticipates that it will take a few months to increase the enrollment rate to pre-sanction levels at the Colorado facilities, which is expected to begin in March. On the other hand, regarding Medicare rates, California's rates were decreased by low single digits (LSD) as of January 1, 2023 while Medicare's were increased by low double digits. In the long run, I anticipate a mid-single-digit increase in PMPM rates as a result of this. Last but not least, I expect margins are anticipated to go back to where they were before the sanctions.

Conclusion

In conclusion, the lifting of sanctions on INNV has created positive narratives for the stock. Management is confident in the short- and long-term profitability of the Colorado facilities, which are set to open for enrollment in March. Importantly, INNV anticipates margins will return to pre-sanction levels, and the company's current efforts are concentrated on expanding its largest market share as quickly as possible. Overall, it appears as though INNV has made progress toward enhancing operations and decreasing expenses.

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