Aveanna Healthcare ($AVAH): A Credit Investor's Guide

A Credit Perspective on Navigating Risks Through Turbulence to Triumph

Situation Overview:

Headquartered in Atlanta, Aveanna Healthcare Holdings Inc. (“AVAH”) is the largest US pediatric home healthcare company, offering a range of services such as enteral nutrition and adult home care. Around 80% of the company’s revenue is derived from private duty nursing (PDN) services, where it provides long-term medical supervision for children and adolescents with complex medical conditions.

The company’s other services also include therapy, respiratory health services, and other specialized care aimed at patients with severe and chronic conditions, facilitating treatment in their homes. Today, AVAH operates across 327 locations in 33 states, employing about 26,000 caregivers. The company’s revenues are diversified across more than 1,500 payors with no payor accounting for more than 13% of revenues. Most of the patients it serves are covered by Medicare, Medicaid, or Medicaid Managed Care Organizations (MCOs) because they are low-income, disabled, elderly, or some combination of the above.

The company was formed in 2017 when Bain Capital merged portfolio company, Epic Epic Health Services, with J.H. Whitney’s PSA Healthcare. Following a period of rapid debt-funded growth, the company went public in April 2021 at $12/share and currently trades on the NASDAQ under the ticker symbol AVAH. Bain Capital and J.H. Whitney continue to sit on the board and remain the company’s largest shareholders with 68% ownership.

Labor Shortage / Wage Inflation

The company’s decision to go public in 2021 coincided with the onset of a challenging labor environment. Persistent nurse staff shortages, exacerbated by the COVID pandemic, hindered AVAH due to the need to hire additional staff at significantly higher wages to meet service demands. AVAH was not alone in this endeavor, as the entire home health sector was impacted by these labor dynamics. The broader issue stemmed from a general scarcity of nursing staff willing to work in home settings at current pay rates, driven by competition from traditional healthcare settings that could afford to pay higher wages compared to Aveanna.

The situation was further compounded by Aveanna’s reliance on Medicaid. Although a significant source of revenue, Medicaid offered lower reimbursement rates and required AVAH to constantly seek out higher rates from payors. Given that states cannot engage in deficit spending like the federal government, their constrained budgets affected their ability to increase Medicaid rates commensurate with inflation. All this being said, despite continued demand and revenue growth, wage inflation outpaced both, resulting in ~400 basis points of margin compression.

Rising Interest Rates

In addition to labor challenges, AVAH struggled with rising interest rates. The company’s capital structure, formed through debt-fueled acquisitions, left its balance sheet highly leveraged. This high leverage was manageable when base rates were ~0%, especially with ongoing secular growth. However, the Fed’s unprecedented rate-hiking cycle turned the company’s all-floating-rate capital structure into a significant burden, substantially increasing interest expense. Following a 30% increase, AVAH’s cash interest payments escalated to a level that surpassed the company’s Adj. EBITDA. Furthermore, this higher cost of capital made the company’s debt-funded roll-up strategy unviable, undermining market growth expectations.

High Leverage, Minimal FCF

On the backs of lower EBITDA, net leverage quickly ballooned to nearly 12x from 7x at the end of 2021. Furthermore, the combination of lower EBITDA and higher cash interest payments, resulted in FCF burn, hampering liquidity. The company’s balance sheet also complicated its ability to compete in a challenging labor market, as it limited its ability to offer competitive wages and invest in growth. With leverage now much in focus, the company’s stock price reached a low of $0.67/share in December 2022, down 94% from its IPO price. AVAH’s 1L/2L TLs also saw new lows, troughing at 76 and 59, respectively. In late 2022, the company underwent a management change in an attempt to rectify these challenges.

Company Response

The company has actively worked to pass higher rates in the states in operates in. While somewhat successful, it’s efforts to increase Medicaid rates in key states like Oklahoma, California, and Texas have faced challenges, particularly with disappointing outcomes in California and Texas, despite these states accounting for 25% of its PDS revenues. Nonetheless, despite some setbacks in rate increases, Aveanna has seen robust PDS reimbursement growth due to the segment’s payor diversity, with double-digit rate updates from eight states and favorable updates from 11 others, positioning it for growth in 2024.

The company has also worked to implement a preferred payor strategy, successfully increasing service hours by negotiating favorable rates with payors that acknowledge the challenges in PDN rates. This strategy is complemented by exploring value-based care models that offer incentive bonuses for meeting specific utilization and quality care metrics. AVAH hopes for 20% of its total service volumes to come from preferred payor relationships, with these payors offering a premium of 25% to 30% over Medicaid rates. Additionally, in its Home Health & Hospice (HHH) segment, Aveanna terminated unprofitable contracts, resulting in a decrease in admissions but a notable ~4% increase in margins, the highest since mid-2021.

Long-Term Outlook Positive

Despite facing ongoing labor-related challenges, the long-term outlook for AVAH looks positive, driven by the a consistent and growing need to care for medically fragile patients. Current industry fundamentals remain solid, with signs of wage pressure beginning to ease. Management has now beat guidance for three consecutive quarters, with EBITDA showing a significant improvement in the most recent quarter.

In the next section, I will review the company’s current capital structure, financials, and covenant considerations. Whether it’s the company’s 1L TL, 2L TL, or equity, I’ll provide my preliminary views on what I think is the best relative value within the capital structure.

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