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Tuesday, June 16, 2009

Sun Healthcare (NASDAQ:SUNH): Upgraded to Outperform at Leerink Swann

Leerink Swann is upgrading Sun Healthcare (NASDAQ:SUNH) to Outperform from Market Perform with a valuation range of $13-$14.

Firm believes the stock has been oversold on reimbursement concerns and the recent restatement at peer SKH. They believe that SUNH has significant organic margin expansion opportunities over the next couple of years and can continue to grow EPS even if Medicare rates are cut modestly.

Reimbursement and Reform Concerns. The recent weakness in SUNH shares mainly reflects fear about potential Medicare rate cuts andbundling under healthcare reform. In early May, CMS proposed a FY10 Medicare payment cut of 1.2% for SNFs. Further, most of the healthcare reform proposals call for bundling some post acute-care payments with hospital payments, which reduces longer-term pricing visibility.

Visibility Should Slowly Improve. Final FY10 SNF (skilled nursing facility) Medicare rule is to be released by early August, and although Leerink is not expecting significant improvement, a few proposals could be clarified or softened. In the past, CMS has used proposed rules to float controversial changes that are often removed from the final rule. Also, while the impact of bundling is unknown, implementation is not likely for many years, giving the industry time to reduce some of the uncertainty.

SUNH Can Grow EPS Even with Rate Cut. Leerink believes SUNH will be able to grow EPS in 2010, even if Medicare rates are cut slightly, through continued rollout of more Rehab Recovery Suites and improvements in patient mix. SUNH facilities with rehab suites have margins 150 bps higher than those without rehab suites. SUNH ended 1Q09 with 48 suites, and the company plans on having 70 open by YE09.

Recent Results Solid. 1Q09 skilled mix and pricing growth were strong, and SUNH generated good cash flow, and reduced debt. Skilled mix was 20.8% and Medicare Part A per diems increased 9% -- both the highest SUNH has reported to date and reflective of its ability to increasingly service higher acuity patients.

Notablecalls: SUNH is one volatile stock and I suspect Leerink's call will cause it to trade up significantly.

I'm guessing 7-10% upside move maybe in store.

What caught my eye was Leerink's comments on how SUNH would be able to grow EPS even with the Medicare rate cuts. Mind you, SUNH is trading around 6x fwd EPS.

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