Chemed Corporation: Shows why it’s so reliable (NYSE:CHE)

Investment Summary

Chemed Corporation (New York Stock Exchange:CHE) is a fairly specialized company that focuses on providing hospice and palliative care services to patients with the help of a network of physicians. Operations are in the US and despite the Covid-19 pandemic hitting the sector, CHE seems to be one of the few that is still growing from those levels. It was not one and revenue is forecast to reach $2.26 billion by 2023.

With higher interest rates and job inflation taking a toll on margins, EPS last report was unfortunately down year-on-year, but over the longer term it is still very strong and I think it will be a benefit. The company’s valuation is slightly above the rest of the sector with an ap/e of 25 or a premium of around 25%. I think this is not enough attractive to make it a buy right now. For investors already in the company, I think holding makes sense and a buy could be set up if the share price falls to lower levels. However, that will most likely only happen if CHE shows signs of slowing growth.

Chemed Company News

CHE recently declared another quarterly dividend, this time at $0.4, marking another round of dividend increases for the company. Over the past 14 years, the dividend has been growing and the payout ratio currently stands at 7.73%. In my opinion, this leaves large amounts of increases in the future without hurting the prospects for expansion through capital deployments.

In addition to the dividend, we also received CHE’s FY2023 second quarter report on July 26. The results showed strong revenue, but the results were less impressive. Revenues came in at $544 million and are setting CHE up nicely to hit the predictions of $2.26 billion by 2023. Turning to EPS, it fell 2.7% yoy to $4.71.

CHE is a company operating in the healthcare services industry, where it focuses on providing hospice and palliative care services to patients. The company operates through a large network of registered doctors and nurses. CHE has divided the options into two different segments, VITAS and Roto-Rooter. The former is the best performer of the last quarter, with revenue up 7.8% and ADC up 6.2%. These are strong results and underscore why, while CHE’s price could be high for a buy, a hold rating will benefit from stock price appreciation as long as they continue to post results like this.

It appears that CHE is becoming more of an FCF-focused company as management sees great potential in the Roto-Rooter segment. They continue to acquire the franchise and expand their market position in almost every state in the United States. The segment requires a minimal amount of capital expenditures and can instead generate a substantial FCF. This will drive expansion into other segments and will also support a growing dividend yield.

Quickly mentioning the forecasts set by management for 2023, revenue is expected to grow by 8.5-9.5% in the VITA segment and 1-2% in the Roto-Rooter segment. In terms of full-year EPS, guidance has been set at $19.9-$20.1. In other words, at the high end, CHE is trading at an ap/e of 25.5.

business profitability

Looking at the margins, I think CHE has come a long way and it makes more sense if it gets the valuation that it does now. Net margins are 10.3%, slightly below the company’s five-year average, but still substantial enough to support the current dividend. If we look at the causes of the lower net margin, I think the main culprit is higher interest rates and also wage inflation, which increases the company’s operating expenses. Also worth noting is the fact that CHE has done a very good job of reinvesting in themselves and the ROC is at 18.9%. With such high profitability, it seems that the market is very bullish on CHE’s future and a higher valuation is expected. However, the valuation appears to be supported solely by these facts, which means that if they are not held, it will likely result in a significant drop in the share price. This introduces risk as we lack a margin of safety if we invested right now.

valuation model

Taking a look at the chart above further highlights why I think CHE makes more sense as a hold than a buy. The lack of future FCF growth ensures that the intrinsic value is well below the current share price. The premium you have to pay for intrinsic value is not worth it. I anticipate 7% annual FCF growth, which is fair in my opinion, as investment in the Roto-Rooter segment is likely to result in this assessment. Cash remains high and the company’s debt position is low: just $16.3 million.

risks

There is a possibility of increased operating expenses, which could affect CHE’s overall profit margins. As the demand for the services provided by CHE continues to increase, the company may find it necessary to allocate increased resources to meet the growing expectations of its customers. This, in turn, could lead to high operating costs as CHE strives to maintain its service quality and customer satisfaction.

However, it is worth noting that while the possibility of increased operating expenses is a valid consideration, it might not be substantial enough to create a bearish outlook for the company. CHE’s management has demonstrated competence in navigating the complexities of its industry, suggesting its ability to effectively manage and mitigate the impact of rising operating costs.

Last words

CHE has been very good at maintaining the momentum of the COVID pandemic and capitalizing on the pressure and demand it has placed on the sector. Revenues are expected to continue to rise and much of the investor anticipation seems to be that CHE will eventually become an even stronger FCF machine, capable of transferring and distributing substantial amounts to shareholders.

However, I do not like the premium required to initiate a position and will instead rate the company as a hold until more favorable price targets are met and a better margin of safety is established.