Healthcare Services Group: Difficulty Overcoming Sector, Economic Challenges

Healthcare Services Group, Inc. (NASDAQ:HCSG) and the sector it competes in have never returned to pre-pandemic levels, and looking ahead, there are no visible catalysts to suggest that’s going to change anytime soon, although management sees an improving labor situation that may be a slight tailwind in the quarters ahead.

With nursing homes, retirement complexes, rehabilitation centers, and hospitals tending to be recession proof or at least recession-resistant, it’s possible under a worsening economic downturn the company could be the beneficiary of a looser labor market that has been tight for some time.

That’s important because there are limitations concerning occupancy based upon labor availability.

For now, probably the major focus of HCSG is concerning the modification of contracts in order to capture current and future inflation. Most of them appear to be near and end, and it should improve the company’s performance in the quarters ahead, albeit at a very modest level if it does.

In this article, we’ll look at the latest numbers from HCSG, sector-specific headwinds, and why it’s likely to continue to languish for the foreseeable future.

Recent numbers

Revenue in the third quarter was $414.5 million, basically flat from the $416 million in revenue generated in the third quarter of 2021. Revenue for the first nine months of 2022 was $1.27 billion, compared to revenue of $1.22 billion in the first nine months of 2021.

Net income in the reporting period was miniscule at $322,000 or $0.00 per share. Net income for the first nine months of 2022 was $18.5 million or $0.25 per share, compared to $43.8 million or $0.58 per share in the first nine months of 2021.

Cost of services in the third quarter of 2022 was $376.9 million or 90.9 percent. At the time of the earnings call management said it remained on track to reduce cost of services to 86 percent based upon contract modifications.

At the end of the third quarter of 2022 the company held cash and cash equivalents of $20 million, compared to $70.8 million at the end of calendar $2021.

The board of directors approved of a dividend increase to $0.215, the 77th consecutive increase since the dividend was introduced in 2003.

Industry challenges

With HCSG’s business entailing providing “management, administrative, and operating services to the housekeeping, laundry, linen, facility maintenance, and dietary service departments of nursing homes, retirement complexes, rehabilitation centers, and hospitals” in the U.S. market, it has historically been a sector that is resistant to economic downturns and other potential headwinds, yet it is one of the few industries that has yet to recover from the effects of the pandemic.

The size of the workforce and occupancy levels haven’t reached pre-pandemic levels, and that continues to be a headwind to this day.

Over the last couple of quarters, the company has seen some improvement in the number of people applying for jobs and a reduction in employees leaving the company or getting terminated.

Another factor suggesting a sustainable trend is the company has seen the number of job openings decrease, reinforcing the idea that more people are looking for jobs, and when hired are staying longer than in the past.

On the nursing side of things, management said that since March 2022 it has been seeing an incremental increase in the size of the nursing home workforce, although it still remains at a 30-year low for the industry in general.

Why this is important to the performance of HCSG is occupancy in particular is determined by having enough qualified workers in place to meet pent-up demand. This will be an important metric to follow in the quarters ahead.

As for concerns about an economic downturn or recession on HCSG, the sector has historically been recession-resistant or recession-proof from these downturns. As a matter of fact, management believes that because of the nature of the industry that a recession that results in a loosening up of the labor market could be beneficial to the company because potential workers would likely start looking for work at the types of facilities the company caters to.

Under those economic conditions it should result in a significant number of new hires, which could in turn trigger higher occupancy rates.

While this is definitely something that could definitely happen, management acknowledges being in a post-COVID environment is something the industry and the company have never faced before, so it’s not guaranteed the sector will respond to a recession or economic downturn in the same way it has in the past.

Contract modifications

A priority of the company is to continue to work on contract modifications that will result in more favorable terms, which will start to have a modest impact on how the company performs in 2023.

Again, the purpose of the modifications is to capture current and future inflation so the company can mitigate the inflationary effects on its top and bottom lines.

In the next earnings report we’ll find out if the company was able to lower its cost of services from 90.9 percent to its stated goal of 86 percent.

Conclusion

Even though HCSG is taking steps to deal with the difficult hand it has been dealt, there is a long way to go before the company will be able to return to sustainable growth.

It’s doing what it can with what it’s got, and focusing on contract modifications, bill collections, and spending discipline, it is positioning itself for the time when the overall sector improves, assuming it does.

The impact on the pandemic had on how a lot of people view long-term care facilities I think is part of the issue here. In the early stages of the pandemic headlines and pundits continued to focus on the number of people getting sick and/or dying in nursing homes in particular, and I think a lot of people are resisting the idea of taking that risk.

That, and the reduction in labor participation and preference for certain types of jobs that allow for working away from the office, have tightened up the market, making it difficult for HCSG to hire enough qualified people that would result in an increase in occupancy rates.

With those things in mind, I don’t see anything in the near term that is going to change the performance of the company. I think the best-case scenario for now is for it to maintain its performance to the point it will continue to be able to boost its dividend.

And if the stock corrects even further, it could be a fairly safe holding that would deliver a nice dividend at an attractive yield. That assumes the reason for the drop in share price is from selling off or fear, rather than a change in fundamentals or market conditions in the sector.