Assisted Living Concepts (ALC) operates 211 senior assisted living residences in the US with 9,325 units. ALC’s facilities contain 40-60 units and are typically located in middle class suburban towns of 40-50 thousand people.
ALC was spun off from the Canadian company Extendicare at the end of 2006. As a newly independent company, ALC made the strategic decision to shift away from Medicaid pay residents towards a higher percentage of private pay residents. In the past year, private pay accounted for 99% of revenues. While private pay rates are some 30-50% higher than Medicaid rates, the drawback for ALC has been dramatically reduced occupancy. The total occupancy rate has declined from 85% in 2006 to 64% in 2011. ALC has managed to keep revenues roughly flat in the $230 million range since 2007 due to the higher private pay rates. Gross margins have risen from 34% to 42% over the period due to the higher rates as well as cost cutting. ALC has also leveraged their SG&A expense well, and adjusted EBITDAR margins have risen from 28.2% in 2007 to 36.5% in 2011. The net result is EBITDA of $67.8 million and EBITDAR of $85.5 million in 2011 versus EBITDA of $49.3 million and EBITDAR of $63.7 million in 2007.
ALC has also been a consistent CFO generator, kicking out between $44 and $55 million since 2007. Due to the soft private pay market, ALC has been careful about growth capital expenditures, generally only adding capacity at sold out properties. Capex ex “new construction” spend has been around $15 million, so run rate free cash flow is in the $35-40 million range.
The balance sheet is fairly strong with only $86 million in debt versus $68 million in EBITDA and $299 million in tangible equity. ALC owns 161 of their 211 facilities.
At $16.70 a share, ALC is trading at a 10.1% trailing free cash flow yield and 6.9X trailing EBITDA. ALC at these levels is a stable recurring revenue business at a fairly cheap price to free cash flow and a very cheap price on an asset basis. ALC is trading at about $50 thousand per housing unit on an EV basis while they have been building new units in the past few years at a cost of over $100 thousand a unit. The upside in ALC is the opportunity to leverage the heavily fixed cost structure by raising occupancy from the current depressed 64% level.
There appears to be downside protection in ALC given the asset value and consistent free cash flow even with depressed occupancy, but it seems difficult to make a strong case for the upside of growing private pay occupancy. ALC does have some demographic tailwinds- the US Census Bureau expects the 75+ population to grow 45% from 2010 to 2025. And new assisted living unit construction is expected to continue to decline as it has since 2007 . But even in the economy recovery since 2009, ALC’s private pay occupancy has only grown from 5,266 to 5,364 units. The problem is that seniors are having a hard time affording assisted living. The soft housing market hurts as the equity in seniors’ existing homes is typically their primary source of funds to pay for assisted living. And with fixed income earning next to nothing, their investment portfolios are no longer a great source of income either. It is hard to see either a dramatic change in either factor in the near future, leaving ALC with speculative upside.
While ALC has many merits, I am worried about the potential for it to be a value trap given the expected difficulty they will continue to have in growing occupancy. Gains to EBITDA in the past few years have mostly come through expense reductions, and I wonder how much they have left to cut. And while their trading multiples have come down, they can always fall further, especially for a business with some regulatory risk (in the past week ALC disclosed an issue surrounding state licenses that might be revoked at several facilities).