Steep cuts in U.S. put pressure on Extendicare stock

Stock in Extendicare Real Estate Investment Trust took a pounding from investors Tuesday as the nursing home operator said its revenues will become an early casualty of U.S.-government cost-cutting.

MARKHAM, Ont. — Stock in Extendicare Real Estate Investment Trust took a pounding from investors Tuesday as the nursing home operator said its revenues will become an early casualty of U.S.-government cost-cutting.

The Centres for Medicare & Medicaid Services, which administers public health plans in the United States, announced last week it will reduce funds for skilled nursing facilities by 11.1 per cent next year.

The cuts, amounting to US$3.8-billion, were much steeper than expected and are coming all at once instead of being phased in. Analysts say Medicare funds made up about a quarter of Extendicare’s total revenues.

Markham, Ont.-based Extendicare (TSX:EXE.UN), which has an estimated 75 per cent of its operations in the United States, lashed out at the cuts as “ill-considered” and said they would have a “significant and immediate” impact on jobs in the industry, as well as on seniors.

Stocks for similar American companies were hammered on U.S. markets Monday, and investors shed Extendicare units when trading resumed on the Toronto Stock Exchange Tuesday, following a civic holiday in parts of Canada.

Extendicare’s units closed down C$1.90, or more than 18 per cent, at $8.28.

“These reductions to Medicare funding, which threaten to destabilize the post-acute care sector, are disappointing to say the least,” Extendicare president and CEO Tim Lukenda said in a statement.

The sector had already contributed significantly to deficit reduction in the face of state Medicaid funding pressures and other budgetary challenges, Lukenda said.

“The ill-considered nature of the … (decision) and its implications for seniors and jobs are significant and immediate, particularly in light of the fragile state of the overall economy,” he said.

Alex Avery, an analyst at CIBC World Markets said Extendicare’s funds from operations next year could be 23 per cent lower than the year before. The cuts don’t kick in until the fourth quarter of this year.

“This funding change certainly presents challenges to Extendicare, which they will have to address through changes to their operations to maximize efficiency and maintain profitability,” he said in an interview Tuesday.

“It’s a substantial setback for Extendicare and all skilled nursing facility operators.”

In a research note, RBC Capital Markets analyst Neil Downey said analysts had been anticipating funding adjustments, but the 11 per cent cut’s “magnitude and timing are worse than many had feared.”

Both he and Avery revised their pricing target to $10 from $11.50.

Meanwhile, analyst Jonathan Kelcher of TD Newcrest downgraded the pricing target to $9 from $11, but maintained Extendicare’s “hold” rating. He said the company had indicated it might increase its cash distributions, but that bump now appears unlikely.

“The lack of tax shield and still relatively high leverage versus its peers are key negative factors, in our view, partially offset by a relatively high distribution yield and partial exposure to historically more stable Canadian government funding,” he wrote.

The analysts added there are several factors that offset the cuts.

Avery said the stock sell off is “overdone” because Extendicare recently completed refinancing at interest rates of 4.5 per cent for terms as long as 30 years

Downey said Extendicare has 22,600 beds, substantial financial flexibility, significant Canadian exposure, and the operating discipline that comes with its monthly cash distributions.

More than two-thirds of Extendicare’s 258 post-acute and long-term senior care centres in North America are in the United States.

However, Lukenda, citing the company’s real estate holding and geographic diversification, said while the funding reductions “will have real consequences for the way we operate our business, we are confident that we will weather this financial storm.”

The Medicare cuts came as the United States narrowly avoided a catastrophic default on its debt, with legislators passing measures that tie an increase in the U.S. debt limit to steep cuts in government spending.

Congressional legislators have approved more than $2 trillion of budget cuts over the upcoming decade.