This company is cleaning up in health care

It benefits as medical facilities outsource their costly laundry and other services.

By TheStockAdvisors May 15, 2013 9:56AM

Senior man in wheelchair looking out window © Tetra Images Getty ImagesBy Benjamin Shepherd, Money & Medicine

When investors contemplate opportunities in the health care sector, the first choices that typically come to mind are sexy investments such as pharmaceutical companies making breakthroughs in treating diseases or hospitals developing ground breaking surgical procedures.

However, many unsung companies deal with the nitty-gritty of patient care and make the best investments because there's value in doing the dirty work. That's where Healthcare Services Group (HCSG) comes in.

Patients in a hospital or long-term care facility receive more than just medical attention; they require clean sheets, towels and gowns and three meals a day.

Running kitchens and laundries are major cost centers for medical facilities, particularly small ones that aren't part of a larger network that can pool resources and run those operations from a centralized location.

In today's cost-cutting environment where every dollar in the health care budget is accounted for and stretched as far as it can go, many facilities are seeking more efficient ways to handle those operations.

Based in Bensalem, PA with a $1.5 billion market capitalization, Healthcare Services Group provides housekeeping and dietary services to more than 3,500 hospitals and long-term care facilities in 47 states.

Medical providers are increasingly compelled to be more mindful of their expenses, as part of recently implemented health care reforms that apply to hospitals and nursing homes. Those facilities that achieve the best possible health outcomes at the lowest cost receive more generous reimbursements.

Consequently, Healthcare Services Group has been extremely successful in securing new contracts for housekeeping services. Because the company typically charges less for these contracts than for dietary services, they're a springboard for new and higher-margin business.

Once the company has provided housekeeping services for several quarters and demonstrated its cost benefit to the facility, it is more likely to secure a higher margin contract to provide dietary services.

That strategy has paid dividends both literally and figuratively over the past several years. The company has averaged better than 15% annual revenue growth over the past three years.

With a better than 90% client retention rate and excellent cost controls, most new business flows straight to the bottom line with free cash flow per share growing from $0.37 to $0.83 last year.

Much of that free cash flow is returned to investors in the form of dividends. Healthcare Services Group has increased its payout in each of the past 39 quarters, for a yield of about 3%.

The company has also been historically generous with stock splits, initiating two 3-for-2 splits over the past decade, and it's solid from a valuation and balance sheet perspective.

Reimbursements under both the federal Medicare and state Medicaid programs are facing tight caps in the coming years under Obamacare and facilities will have to stretch every dollar. One of the easiest ways is to reduce expenses through outsourcing.

While Healthcare Services Group cleans up the industry's mess, its consistent track record of revenue and earnings growth shows the value of undertaking the less glamorous work in health care.

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