AmSurg Is What The Doctor Ordered?

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Business Description

AmSurg Corp. (AMSG) is the owner and operator of ambulatory surgery centers (ASCs). It also provides outsourced physician services to hospitals, ASCs and other healthcare facilities. AmSurg Corporation operates 250 ASC’s in 34 states. They employ 2,900 physicians who deliver services to over 320 healthcare facilities.

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Investment Rationale

The Roland George Investments Program invested in AmSurg Corporation November 2014 based on the stocks significant undervaluation and strong financial outlook. The reasons that the Roland George Investments Program purchased AmSurg Corporation were:

Profitable Health Care Reform:  AmSurg is positioned to capitalize on the increasing number of insured Americans under the Affordable Care Act.  As the need for health services rise, AmSurg will see a growth in their top line revenue, as well as in the same procedure growth. Studies of the impact on use of certain services, mainly primary care, indicate that the coverage expansions are likely to lead to between 15 million and 26 million additional primary care visits annually. The government predicts that between 4,300 and 7,200 additional primary care physicians will be needed to meet these new demands. Increases of the magnitude likely to be generated by the Affordable Care Act will have significant effects on the demand for health services.

Largest In a Highly Diversified Industry: AmSurg is the largest operator of ASC’s in the industry and only maintains a 4.5% market share. Because of their potential for growth in this industry, and cost leading advantage of their structure they are able to take advantage of this fragmented industry choosing new centers in markets of interest to add to their portfolio. The industry is comprised of more than 600,000 centers nationwide in the ambulatory service center designation. The majorities of centers are privately held by physicians and operate on a small-scale model.

Acquisition Growth: AmSurg has great history of making positive acquisitions to increase their top and bottom line growth. AmSurg has focused on adding centers to its portfolio.  On average year over year this has been 7 centers, with an addition to revenue of 7% annually. AmSurg made its largest acquisition to date purchasing Sheridan healthcare for $2.35 Billion.

 

Recent Performance

Since the last analysis in November 2014, AmSurg has gained around 56% compared to the S&P 500’s

-4.39% return.  The following events affected the stock’s performance over this time period.

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Stock price increased due to AmSurg acquisition of Radiology Associates of Hollywood (Move A): AmSurg expands its presence in the radiology space with the purchase of over 50 sub-specialty trained radiologists in Hollywood, FL.

Stock price increased due to AmSurg acquisition of Halifax Anesthesiology Associates (Move B): Sheridan, the Physician Services Division of AmSurg Corp. further expanded its anesthesiology services business through the acquisition of Halifax Anesthesiology Associates. The practice has a staff of 8 physicians and 23 certified nurse anesthetists. The acquisition further strengthens the Physician Services’ division on the east coast of Florida.

Stock price increased due to AmSurg acquisition of Coastal Anesthesiology Consultants (Move C): Sheridan announced the purchase of Coastal Anesthesiology Consultants. The group is comprised of over 25 providers including physicians, certified registered nurse anesthetists and anesthesiologist assistants. The approach expanded its market presence in Florida.

Stock price increased due to Earnings above Expectation (Move D):  AmSurg’s net revenue shot up 131% year over year to $642 million. In the reported quarter, net revenue from Ambulatory Services increased 12% year over year to $311 million with a 5.1% improvement in same-center revenues. In the past quarter, Ambulatory Services added 2 ambulatory surgery centers (ASC) to its base of operations and ended the quarter with 250 centers.

Stock price decreased due to Market Correction and Chinese Market Crash (Move E): World stocks plunged as a global selloff accelerated on fears about the health of China’s economy. The Standard & Poor’s 500 entered into correction territory for the first time since 2011 in one of the most volatile trading days ever, as a rout in global equity markets deepened.

Financial Performance

Second Quarter 2015 Highlights: AmSurg delivered solid second-quarter 2015 results. The adjusted EPS for the quarter was $0.97, well above the expectation of $0.84. Strong growth was driven by successful execution of the company’s organic growth and acquisition strategies in both the Ambulatory and Physicians Services businesses. Specifically for the Ambulatory Services division, net revenues increased 12% for the quarter.  In the Physician Services area, net revenue for the quarter increased 24.3% over the prior year.

Acquisitions contributed 11.8% to AmSurg’s revenue.

Revenue Breakdown: AmSurg’s revenue is split between ambulatory centers and physician services. On a year-to-date basis, the ASC division contributed 49% of the total revenue. The Physician Services division contributed about 51% of the total revenue to the Company, and also, it contributed about 36% directly from the anesthesia service.

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Management Expectations: From AmSurg’s own forecast, they have established third quarter guidance as follows: Same-center revenue increase of 3% to 4% for Ambulatory Services and same-contract revenue growth of 8% to 10% for Physician Services. According to the estimates given by AmSurg, ASC division will increase its revenue to approximately $323.5 million, while the Physician Services division will increase its revenue to roughly $360 million. The estimated growth is due to the attainment of new centers and services and also 9 centers that are currently under development by AmSurg.

Analyst Recommendations:  AmSurg has developed a reputation for regularly beating earnings.  Through its acquisitions and organic growth, AmSurg has been able to maintain stable earnings growth year over year coming out of the Recession. Analysts evaluate AmSurg favorably. AmSurg consistently beats analyst estimates with strong quarterly results (see Exhibit 3). AmSurg Corp reported a strong second-quarter 2015 with adjusted earnings per share (EPS) of 97 cents from continuing operations, reflecting a solid 44.3% rise from the year-ago quarter. Solid revenue growth in the quarter was primarily responsible for the year-over- year earnings improvement.

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Growth Drivers:

Health Care Reform: The Intention of this new healthcare initiative is to bring access to affordable healthcare to all Americans. The legislation in its full form requires that all Americans have health insurance coverage either through their employer, a public program such as Medicaid or Medicare, or by purchasing coverage from a state-based health insurance exchange.  The law carries out further plans in 2016 as well with target number of uninsured in the single digits, this is anticipated to drive demand for healthcare to all- time highs, and we have already seen the effects in the percentage of GDP that is accounted for in healthcare spending rising from 16% to a projected 18.5% in 2016. The effect of the affordable healthcare will drive more patients to lower cost providers such as outpatient, and ambulatory service centers.

Aging Population: As the senior population continues to rapidly expand with the aging of the baby boomers and the demand for hospital services generally increases due to the Affordable Care Act, ASCs will become increasingly appealing as an inexpensive and efficient conduit to provide care and meet increasing demand. The existing body of evidence shows clearly that for many indications, ASCs are a safe alternative to hospitalization.

Competitive Positioning

National Presence: In the past, the Health Facilities industry has been highly fragmented, and still is in many cases. AmSurg is capitalizing on this fragmentation with their strong national presence that has expanded with the purchase Sheridan Healthcare. Their strong presence allows them to lower overhead cost at the individual center level, by pushing certain tasks to the corporate level, leveraging their size in their favor. This has also allowed them to make favorable moves in joint venture opportunities with other health service providers to better diversify their contract customers.

Shared Costs to Boost Profitability:  AmSurg and Sheridan finalized their integration and now they are

able to share in each other’s overhead expenses, lowering the overall margin spent on accounting, marketing, etc. This vertical integration will in most part be in the anesthesiology department of their centers. The benefit of moving the anesthesia in house is it lowers the cost over all and ensures that they will be able to supply all the centers that need anesthesia services. The combination of the shared overhead, vertical integration, and the possibilities for cross promoting across business lines gives them an opportunity to increase revenue at a lower cost, boosting the profitability of the company as a whole.

Financial Analysis

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Demand Growth:  As the baby boomer population ages the need for certain services rises appropriately. With gastrointestinal, and optometry being two areas of high potential for growth as insurance carriers begin to require prescreening in these two areas for preventative care. According to the commonwealth fund, hospital outpatient departments will see, on average, 1.2 to 11.0 additional visits per week, or an average increase of about 2.6 percent nationally. Baby Boomers represent approximately 76 million Americans in the population today, as this population continues to age their need for medical care rises, increasing the demand for centers that can cater to the needs and wants of this generation. This growing population of elderly citizens, along with growing number of insured Americans as a whole is anticipated to have an impact on demand that could drive it above current capacity.  AmSurg is designed in such a way that they will be able to capitalize on this demand for health care needs.

Economic/Industry Effects: The health care facilities industry historically shows a two-month lag in relation to GDP. With expected GDP to rise we can expect to see an increase in health care facilities revenue. Also the impact of the affordable care act should be favorable, as the industry sees more people insured; this should result in more patients seeking care. The analysis provided by the government indicates that the Affordable Care Act is expected to result in roughly 20.3 million additional primary care visits nationally, with people newly insured through the marketplaces accounting for more than a third of these visits. The fact that many carriers are now having to control cost as much as possible has also led to the thought of carriers making requirements that their patients use more affordable options that do not sacrifice care, such as ambulatory care of hospitals.

I constructed a Pro Forma Income Statement to estimate AmSurg’s revenue and earnings per share growth for the second half of 2015 and the first half of 2016. The following events are how I developed this pro forma:

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Revenue Estimates: According to my analysis, I expect AmSurg’s 2015 revenue to increase due to a combination of factors. Management estimates such as Q2 2015 conference call and guidance suggests that 2015 revenue will grow 1% for Q3 2015 and 2% for Q4 2015 to close the year with an estimated 2.52 billion. Bloomberg analysts expect a slight decrease of 1.50% in Q3 2015 and a positive growth of 5.77% in Q4 2015. Historical revenue shows an average positive growth of 8.71%. The three factors are weighing differently towards my final estimate used in my Pro Forma.  I gave analysts a weight of 30% since it contains an unbiased view of the stock, fairly good rating and the quantity of analysts following the company. I gave historical revenues a lesser weight of 10% due to the revenue volatility post Sheridan acquisition. I gave management a weight of 50%. Based on these estimates, I expect AmSurg’s 12-month revenues to reach $2.623 billion dollars, an increase of 15.63% over the prior period.

Cost of Goods Sold Estimates: I estimated the cost of revenue based on historical average over the last year post Sheridan integration. Management is cutting costs by creating bigger cost synergies between the ASC’s and Sheridan Physician Division. The Cost of Revenue has been consistent in the past years. Every year approximately 7 centers are either acquired or developed making a slight increase in the COGS percentage growth. The one-year range from Q3 2014 to Q2 2015 is from $42,241 to $45,790 showing only an 8.40% percent growth. I predict that AmSurg’s cost of revenue will stay consistent during the next quarters increasing by 2.75%.

SG&A (& Other) Estimates: The Selling, General and Administrative Expenses have maintained an average stable growth of 7.40%. The range of the last four quarters is from $345,061 to $426,426 showing reasonable growth due to constant acquisition and new practices. Amsurg’s Q2 Conference Call estimates that operating expenses will only grow by an average of 6.50% since they are always looking to lower operating expenses by creating a bigger cost synergy between AmSurg and Sheridan Corporation.

Earnings Per Share Estimates: Based on AmSurg’s estimated revenue growth, cost of revenue, interest expense and operating expense, I expect earnings per share of $3.94 for the next 12 months, representing an 29.15% increase from the prior period.

Valuation

Sales Franchise Value Model: Referencing my Pro Forma, I anticipated revenue growth rate of 15.63% for AmSurg.  Using the CAPM, I estimated a required rate of return for the model of 10%.  AmSurg has a current profit margin of 3.15% and I estimate that AmSurg’s future profit margin will grow to 6.14% as the company continues to cut costs and increase their margins through costs synergies. The current sales per share are $45.39.  The model shows AmSurg being undervalued by 19.34% with a fair price of $95.52.

Growth Duration Model: Referencing my Pro Forma, I anticipated EPS growth of 29.15% for AmSurg. The industry P/E used in the model is 19.89 and an estimated industry growth used is 22.70%. When compared to the industry, AmSurg is estimated to be undervalued by 1.73%, with a fair price of $81.71. AmSurg does not have any true competitor in this industry.

Average Fair Value: After combining my two models, I found a fair value for AmSurg Corporation of

$88.62.  This indicates that shares of AmSurg Corporation are additionally undervalued by 10.72%.

Recommendation: AmSurg Corporation is the leading operator of Ambulatory Surgery Centers and is positioned to capitalize due to healthcare reform lowering the number of uninsured and driving demand to an all-time high. The unique business model presented by AmSurg provides clients with a lower cost alternative than Hospitals. The company’s ability to acquire, develop and operate ASCs sets them apart from their competition.  I recommend at this time that the Roland George Investments Program HOLD all 1565 shares of AmSurg Corporation (AMSG).

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