Encompass Health Delivers Strong Earnings, Signals Resilience in Healthcare Sector

Encompass Health (NYSE:EHR) reported third-quarter 2023 results that not only beat Wall Street expectations but also underscored its position as a leader in post-acute care. The company’s GAAP earnings per share (EPS) of $1.37 exceeded estimates by $0.21, while revenue of $1.45 billion surpassed projections by $20 million. This performance highlights Encompass Health’s ability to navigate a challenging healthcare landscape, driven by operational discipline and strategic investments in high-margin rehabilitation services.

Financial Strength Amid Sector Headwinds

The earnings beat was particularly notable given the broader pressures facing the healthcare sector, including rising labor costs and reimbursement challenges. Encompass Health’s revenue growth of 2.8% year-over-year (YoY) reflects strong demand for its inpatient rehabilitation facilities (IRFs) and home health services. Notably, the company’s adjusted EBITDA margin expanded to 16.5%, up from 15.2% in the prior-year period, signaling improved cost management. Management attributed this to efficiency gains in staffing and supply chain optimization.

Investors have responded positively to these results, with shares rising 5% in after-hours trading following the report. Year-to-date, the stock has underperformed broader markets, down approximately 7%, but the third-quarter results may catalyze a reassessment of Encompass Health’s valuation.

Operational Leverage and Market Opportunities

Encompass Health’s focus on high-acuity patient care—such as neurorehabilitation and spinal cord injury recovery—has positioned it to capitalize on a growing demand for specialized post-acute services. With an aging U.S. population and rising rates of chronic conditions, the rehabilitation sector is expected to expand at a 4.5% compound annual growth rate (CAGR) through 2030, according to industry analysts.

The company’s home health division, which now accounts for 28% of total revenue, also presents a growth lever. Its integration with Encompass Health’s hospital-based services creates a “continuum of care” model that reduces readmission risks for patients and enhances reimbursement through bundled payment programs.

Risks and Considerations

Despite the positive results, Encompass Health faces headwinds. The CMS 2024 IRF prospective payment system (PPS) update, which reduces Medicare reimbursement rates by 0.7%, could pressure margins in 2024. Additionally, labor shortages in skilled nursing and rehabilitation professions remain a systemic challenge. Management noted that wage inflation has slowed to 3% in recent quarters, but competition for talent persists.

Conclusion: A Resilient Play in Healthcare’s Recovery Segment

Encompass Health’s third-quarter results affirm its ability to generate consistent cash flows and adapt to regulatory and market dynamics. With a debt-to-EBITDA ratio of 2.1x—well within investment-grade thresholds—the company has the financial flexibility to invest in technology, facility upgrades, and strategic acquisitions.

Looking ahead, the stock’s current valuation of 13.5x 2023E EPS appears reasonable given its defensive profile and growth tailwinds. Should Encompass Health maintain its margin expansion and capitalize on its home health integration, it could deliver mid-single-digit annual EPS growth over the next three years. For investors seeking exposure to a resilient healthcare subsector, Encompass Health’s combination of stability and growth potential makes it a compelling option.

Data as of October 2023. Past performance does not guarantee future results.