This Healthcare Transportation Provider Is Really Going Places

Providence Service (NASDAQ: PRSC  ) , a provider of human social services and community transportation, is undervalued with an EBITDA -- earnings before interest, taxes, depreciation, and amortization -- multiple of only 6.8 due to uncertainty regarding the bidding process for new contracts and state participation in Medicaid expansion. However the long term bullish outlook driven by multiple demand drivers (e.g., new contracts, geographic expansion, membership growth, rate increases) remains intact.

For the first nine months of 2013, revenue rose 3% to $845.8 million as non-emergency transportation revenue rose 6% to $583 million while revenue from human services decreased 2% to $262.8 million . However, adjusted EBITDA rose 46% to $44.2 million as the EBITDA margin increased from 3.3% for the first nine months of 2012 to 5.1% in the first nine months of 2013. This impressive financial performance is not merely a recent trend either as shown in the chart below.

Source: SEC filings; in millions

This cash flow growth resulted in the cash balance rising to $91.1 million in the quarter ended in September from $55.9 million at the end of last year . There is greater financial flexibility due to a recent refinancing  and the continued debt reduction shown in the chart below.

Source: SEC filings; in millions

Rather than focus on near term challenges, investors should focus on the following three long term growth drivers. First, the privatization and outsourcing trend should continue as companies such as Providence can provide higher quality services more efficiently and economically in a client's home or community compared to an institutional setting such as psychiatric hospital or residential treatment center . This is a secular rather than cyclical trend as states are always looking for ways to reduce costs (especially in costly programs such as Medicaid) because they do not have the option of running persistent deficits like the federal government.

Second, health care reform (e.g., Medicaid expansion under the Affordable Care Act) and a growing number of eligible beneficiaries of government sponsored services should generate additional revenue growth.

Third, although Providence expanded largely through acquisitions (e.g., 22 acquisitions from 2002-2008) , organic growth due to attrition should contribute a more meaningful share going forward. However there is still an opportunity for consolidation given the fragmented nature of the industry.

Peer comp
A peer comp is difficult given that many of its direct competitors are either privately held, not-for profit social services organizations or faith-based agencies. However Providence has multiple competitive advantages including a wide geographic reach (43 states and D.C.) , breadth of services offered, as well as strong client and payer relationships. Moreover, management said that its low cost home and community based service delivery system is attracting payers that historically only contracted with not-for-profits .

Although not a true peer, air medical transport provider Air Methods (NASDAQ: AIRM  ) is in the same industry and provides a somewhat similar service. While its EBITDA multiple of 12.2 is almost twice that of Providence, this is clearly deserved given Air Methods' significantly higher gross profit margin (37.7% v. 9.5% for Providence Service as of third quarter 2013). Its similar growth profile highlights the attractive opportunity for the largest players such as itself and Providence that provide such an in-demand service to a growing number of people.

Bottom line
Investors should jump at the chance to buy great companies that go on sale due to temporary challenges. Few actually do as the fear of losing money overcomes the desire to make money. However the low valuation significantly reduces the downside while the improving financials and multiple demand drivers should bring Providence back to its normal growth trajectory in the intermediate term.


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