One of the key components to most wide-moat companies is some semblance of pricing power -- that is, the ability to control end-user pricing for the company's product or service. Companies that rely wholly or in part on Medicare, though, have to surrender some of that pricing power.
Apria Healthcare (NYSE:AHG) is finding itself squeezed by new Medicare policies regarding payment for home respiratory care.
Revenue for the fourth quarter grew just under 6%, while net income (excluding a writedown) dropped about $1 million from the prior year. Revenues in December were hurt both by prior Medicare reimbursement cuts and the absence of business from home health services firm Gentiva (NASDAQ:GTIV).
Like competitor Lincare (NASDAQ:LNCR), Apria is facing further anticipated cuts in Medicare reimbursement. While those cuts have been delayed, they will eventually come -- sometime in 2005. When they do, Apria will likely see reimbursement for respiratory medicines cut by up to half, and rates for oxygen likely cut by 10% to 20%.
Unlike Lincare, Apria is not quite as dependent on Medicare for its revenue. While Lincare garners about two-thirds of its revenue from Medicare, Apria's percentage is more like 30%.
Nevertheless, private insurers (the bulk of Apria's payors) are apparently looking at the Medicare cuts as an opportunity to squeeze their own payments, and Apria has reported that some customers (like Gentiva) are pushing for lower reimbursements. In the case of Gentiva, the company decided to forgo renewing its contract, as the pricing offered was not sufficient in Apria's view.
Acquisitions will continue to be a major component of Apria's growth strategy, but improved productivity is also important. Though the company is trying to make progress with cost-cutting and improved efficiency, its operating margins for the fourth quarter were down year-over-year (13.7% vs. 14.8%) and are considerably below those of Lincare.
While the business models between Apria and Lincare are not totally comparable -- they target different customers and have different service offerings -- the gap in operating margins (Lincare's was 37.3% for the fourth quarter) is nonetheless considerable. This suggests that Apria has room for improvement, and that will be increasingly important as pricing pressure hurts growth.
Investors considering Apria shares must also be aware of an ongoing (since 1998) government investigation pertaining to billing. While the company maintains that the issue concerns clerical errors (as opposed to fraud), investors should be aware of the potential risk of a government sanction or settlement.
Valuation is not out of line, but that doesn't necessarily make these shares a bargain. While Lincare's much greater dependence upon Medicare is a definite concern, it has nevertheless managed to post higher growth and better margins than Apria. Fools should of course do their own due diligence, but Lincare looks to be the better bet at present.
Fool contributor Stephen Simpson, CFA, has no ownership interest in any stocks mentioned.
