Consider Buying Encompass Health Stock For 20% Upside

We believe that the stock price of Encompass Health (NYSE: EHC), best known for its facility-based and home-based post-acute healthcare services, could offer an upside of roughly 20% from the current levels. EHC stock trades at $68 currently and it is down 17% from the pre-Covid high of $81 seen in February. Also, EHC stock has gained 38% from the low of $49 seen in March 2020, as the Fed stimulus largely put investor concerns about the near-term survival of companies to rest.

For Encompass Health, the inpatient rehabilitation business was impacted by the pandemic in Q2, as we discuss in the sections below. However, the company started seeing a recovery in June, and it will likely extend into Q3 as well. The company in its Q2 earnings conference call stated that inpatient rehabilitation volume rebounded to 95% of pre-pandemic levels. In view of the economic growth and with the vaccine in sight for the coronavirus, we believe that EHC stock has more than 20% upside in the near future, led by an increase in demand for inpatient rehabilitation as well as home health and hospice services. Our conclusion is based on our detailed analysis of Encompass Health stock performance during the current crisis with that during the 2008 recession in an interactive dashboard analysis.

2020 Coronavirus Crisis

Timeline of 2020 Crisis So Far:

• 12/12/2019: Coronavirus cases first reported in China
• 1/31/2020: WHO declares a global health emergency.
• 2/19/2020: Signs of effective containment in China and hopes of monetary easing by major central banks helps S&P 500 reach a record high
• 3/23/2020: S&P 500 drops 34% from the peak level seen on Feb 19, as Covid-19 cases accelerate outside China. Doesn’t help that oil prices crash in mid-March amid a Saudi-led price war
• From 3/24/2020: S&P 500 recovers 55% from the lows seen on Mar 23, as the Fed’s multi-billion dollar stimulus package suppresses near-term survival anxiety and infuses liquidity into the system.

In contrast, here’s how Encompass Health and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of S&P 500 index
• 1/1/2010: Initial recovery to levels before accelerated decline (around 9/1/2008)

Encompass Health vs S&P 500 Performance Over 2007-08 Financial Crisis

EHC stock declined from levels of around $15 in September 2007 (pre-crisis peak) to levels of around $7 in March 2009 (as the markets bottomed out), implying EHC stock lost 55% from its approximate pre-crisis peak. It recovered post the 2008 crisis, to levels of about $16 in early 2010, rising by a massive 139% between March 2009 and January 2010. In comparison, the S&P 500 Index saw a decline of 51% followed by a recovery of 48%.

Encompass Health’s Fundamentals in Recent Years Look Strong

Encompass Health’s Revenue grew steadily from $3.6 billion in 2016 to $4.6 billion in 2019. The company’s margins expanded from 6.8% to 7.8%, resulting in a 32% EPS growth from $2.77 in 2016 to $3.65 in 2019. However, given the impact of the Covid-19 pandemic, the company’s Q2 2020 revenues were 5.4% below the level seen a year ago, and the EPS figure for the quarter slid from $0.93 in Q2 2019 to $0.34 in Q2 2020.

Does Encompass Health Have A Sufficient Cash Cushion To Meet Its Obligations Through The Coronavirus Crisis?

Encompass Health’s total debt has increased slightly from around $3 billion in 2016 to $3.6 billion at the end of Q2 2020, while its total cash increased from $40 million to $475 million over the same period. The company also generated $252 million in cash from its operations during the six month period ending June 2020, and it appears to be in a good position to weather the crisis.

CONCLUSION

Phases of Covid-19 crisis:

• Early- to mid-March 2020: Fear of the coronavirus outbreak spreading rapidly translates into reality, with the number of cases accelerating globally
• Late-March 2020 onward: Social distancing measures + lockdowns
• April 2020: Fed stimulus suppresses near-term survival anxiety
• May-June 2020: Recovery of demand, with the gradual lifting of lockdowns – no panic anymore despite a steady increase in the number of cases.
• July-October 2020: Poor Q2 results and lukewarm Q3 expectations, but continued improvement in demand, a decline in the number of new cases, and progress with vaccine development buoy market sentiment.

Going by the historical performance and in view of the recovery seen in June, we believe that EHC stock has roughly 20% room for growth in the near future.

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