Patients served by home health providers aren't exactly having the time of their lives. After all, there's nothing fun about needing to bring someone into your home to take care of you. But that doesn't mean that shareholders of home health providers can't have a little fun. In fact, for shareholders of some companies, the past five years have been an absolute blast!

Shares of Almost Family (NASDAQ:AFAM) have risen eightfold in the past five years, even as the current bear market wiped out the gains of many stocks. Obviously, the company's doing something right -- but you still might want to stay away for the time being.

Like competitors Amedisys (NASDAQ:AMED), Gentiva Health (NASDAQ:GTIV), and LHC Group (NASDAQ:LHCG), Almost Family operates in the home health industry. Rather than forcing those who need round-the-clock care to move to an inpatient facility, the company sends nurses and other qualified personnel to take care of them in the comfort of their own homes.

There's a lot to like about the company. Almost Family's earnings have grown at a 67% annualized clip over the past five years, with a return on equity above 22%. It also has tenured and adept management. But let's delve into why I think you should keep clear of the stock for now.

Where's the cash?
The first issue is the quality of the company's earnings. While Almost Family reported $13.2 million in net income in the trailing 12 months, the company actually only produced $4.5 million in operating cash flow, a big discrepancy attributable almost entirely to burgeoning accounts receivable. Normally, you would like operating cash flow to outpace earnings, as you see with companies like Chipotle Mexican Grill (NYSE:CMG).

The big, red, waving flag in Almost Family's case is that receivables are growing much faster than sales, indicating that customers are taking longer to pay for services, on average. In the past year, accounts receivable increased by 108%, even excluding the impact of acquisitions. In the meantime, revenues grew at a much slower rate of 49%. In other words, receivables increased more than twice as fast as sales!

Now, the receivables situation could simply be due to the vagaries of government bureaucracy. But it could also be a sign of much more serious problems, such as:

  • Coding disputes with Medicare, or coding that Medicare may claim is overly aggressive.
  • Disputes over patient eligibility and compensation with Medicaid, which may become increasingly likely as states cut coverage and reimbursement.
  • Increasing bad debt from private payers, which some hospitals are running into as the downturn worsens.

Management itself even notes that there is a "reasonable possibility" of changes in estimates (write-downs) in the near term, based on these sorts of problems.

At your mercy
One thing to look for in a great business is pricing power. Unfortunately, Almost Family has none. The amount the company receives for its services is almost entirely dependent on government programs like Medicaid and Medicare, which together made up more than 90% of revenue in 2007. And if those programs change their payment policies, they can alter the fundamental dynamics of the industry and dramatically impact profitability -- overnight. As Medicare costs balloon out of control, and the government seeks to contain them, significant legislative changes seem virtually assured. In short, investors have no ability to predict profitability into the future.

As previously noted, many states have cut or are considering cutting Medicaid coverage and compensation in the face of state budget crises. And it appears that the federal government is targeting Medicare compensation, too. For example, the Medical Payment Advisory Commission believes that home health margins, particularly private home health margins, are much too high, and it's actively seeking significant cuts in compensation.

To buy or not to buy: That is the question
My ultimate position on Almost Family: Take a pass for now.

Until Almost Family starts turning its receivables into actual cash, investors should be skeptical of its earnings. The case for Almost Family clearly hinges upon its growth potential, but the bottom line is that there is no ability to predict the future of this company. Medicaid is in flux, there is always the risk of a legislative overhaul gutting home health care, and Medicare is actively seeking to squash home health profits, recommending significant reductions in payments.

If the company were selling at such a cheap price that these risks became tolerable, that'd be one thing. But with a P/E of 18, Almost Family isn't dirt cheap. And while analysts predict 20% earnings growth next year, that growth will come under pressure as the company matures and margins compress over the long term -- a point stressed by the company's own management. Given the company's earnings quality and risks, there just isn't a big enough discount to justify buying here.

Besides, the investing sea is afloat with better opportunities. Outside the home health space, I like many companies with valuations I find more attractive. Those include niche clothing manufacturer Volcom (NASDAQ:VLCM) as well as the exciting, paradigm-shifting technology of Intuitive Surgical (NASDAQ:ISRG), which now sports a much more compelling valuation than it did in the past. For now, Almost Family can't compete.

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