Seven months into its initial public offering (IPO), BrightSpring Health Services (NASDAQ:BTSG) stock has performed underwhelming. Though it trades near the higher end of its 52-week range of $7.85 to $12.79, it trails its IPO price of $13. Despite tackling important pain points in its niche, the market’s reception of the home-based healthcare and pharmacy services provider has been relatively lukewarm. Moreover, despite my generous FCF growth projection pointing to a double-digit upside for BTSG stock, its erratic numbers warrant caution. Hence, I’m sticking with a Neutral [Hold] position on the stock.

Company Overview And Growth Drivers

BrightSpring Health Services adopts a multipronged approach in delivering varied and tailored healthcare solutions to high-need and complex patients. It looks to efficiently address multiple pain points, aiming for a substantial reduction in the costs associated with hospital care by offering affordable, home-based services. Moreover, it also looks to tackle the issue of fragmented care by providing a seamless patient experience. On top of that, its medication management minimizes errors for those with complex needs.

Supporting BrightSpring’s case, a 2023 article in The Journal of Health Services Research & Policy showed that older adults with complex care needed frequent hospitalization due to insufficient community support. Moreover, the recent developments in integrated care, including the upcoming Age-Friendly Hospital Measure by CMS, underscore the demand for BrightSpring’s home-based services.

BrightSpring has thrown in a lot of big numbers in its latest corporate deck, aiming to build on the strength of its long-term bull case. It estimates a whopping $1 trillion total addressable market, serving over 400,000 patients daily while dispensing over 37 million subscriptions last year.

Moreover, highlighting its massive market potential, the deck showed that roughly 70% of seniors suffer from more than a couple of chronic conditions, with 18% managing more than six or more. Additionally, challenges involve reliance on ER for preventable issues, fragmented care, and uncoordinated services, costing $100 billion in avoidable annual spending.

Additionally, there’s a strong push to cut healthcare costs in the U.S., focusing on minimizing hospital stays to lower expenses and reduce the risk of hospital-acquired infections. Given the challenges outlined and the aging population with rising health conditions, BrightSpring is positioned to benefit immensely.

Competitive Positioning

Naturally, with such a massive market opportunity, competition is inevitable. BrightSpring competes with a mix of established players in health provider services and pharmacy solutions. Four of the top ones include:

· Amedisys, Inc. (AMED)

• Market Cap: $3.198 billion
• Industry: Health Care Services

· Encompass Health Corporation (EHC)

• Market Cap: $9.218 billion
• Industry: Health Care Facilities

· Addus HomeCare Corporation (ADUS)

• Market Cap: $2.398 billion
• Industry: Health Care Services

· Option Care Health, Inc. (OPCH)

• Market Cap: $5.44 billion
• Industry: Health Care Services

· BrightSpring Health Services, Inc. (BTSG)

• Market Cap: $2.168 billion
• Industry: Health Care Services

All these sport market caps that are significantly higher than BrightSpring’s. With a market cap of roughly $2.168 billion, the firm sits on the lower end of the small-cap spectrum, making it a relatively smaller player in the market.

Likewise, based on growth metrics, we can see that BrightSpring’s competitors demonstrate greater stability, with three consistently profitable. These seasoned players have been at it much longer, underscored by their superior performance metrics compared to BrightSpring’s shaky results.

Furthermore, this trend is reflected in their liquidity positioning, which shows BrightSpring’s competition in a much brighter spot. The total cash per share for the company is just 15 cents per share, compared to a towering debt load of more than $2.91 billion. Leverage is a significant part of the bearish narrative surrounding BrightSpring, which we’ll go into a little more detail later in the article.

Financial Performance Lacks A Punch

BrightSpring’s financial performance is erratic, marked by a sharp slowdown in top-and-bottom-line growth and a concerning debt burden.

Over the past five years, we’ve seen a significant decline in company sales since its peak growth in 2019, when they soared upwards of 78%. Since then, revenue growth has hovered between 15% and 20%, throwing shade on its management’s lofty claims. Naturally, the trend can be seen across its bottom line, where its operating income growth has been in the negative over the past three years. Additionally, its net loss of $154.6 million last year represented a 186.8% drop from the prior-year period. Beyond the sales decline, the surge in operational expenses raises red flags, constituting more than 14.6% of 2023 sales, up from 11.9% in 2018.

Perhaps the most concerning bit is its liquidity positioning, which shows just $25 million in cash, roughly 90.5% behind its high point in 2020, posting $262 million. Additionally, with its net debt at $2.89 billion, the firm’s total debt to equity stands at a worrying 181%. What’s troubling is that its net debt has hovered above the $2.4 billion mark over the past five years. Unsurprisingly, with an Altman Z-Score of 2.12, BrightSpring sits firmly in the distress zone. To put things in perspective, the Altman Z-Score is a metric used to assess a firm’s likelihood of bankruptcy. Additionally, with a current free cash flow of $135.8 million, the company is estimated to have just 12 months of financial runway.

Current Valuation Lacks Appeal

BrightSpring Health Services went public in late January with an IPO price of $13 per share. Notably, the price was expected to fall in the $15 to $18 range. Since its debut, the stock has been remarkably volatile, underperforming the S&P 500, yet it now hovers near its IPO price. It has effectively recovered from March lows and has shown decent momentum of late.

A quick look at its valuation metrics reveals an unappealing stock. From the snapshot above, the BTSG stock trades more than 61 times GAAP earnings, almost 90% higher than the sector median. A more fitting metric for evaluating BTSG stock could be price-to-cash flow, which highlights the firm’s efficiency in generating cash from operations. On that front, it’s trading more than 21 times the trailing twelve-month cash flows, making it remarkably pricey compared to its competition. Nevertheless, estimates from seven Wall Street analysts suggest BTSG stock offers upwards of a 28% upside potential from its current price to roughly $16.17 per share.

Moreover, I applied a fair-value model to predict what BTSG stock is worth at this point. However, estimating the weighted average cost of capital (WACC) proved slightly more complicated than it would be for more established companies.

The equity risk premium is based on the S&P 500’s 10.32% average annual return (1957-2023) and a 4% estimated risk-free rate from 10-year bond yields. Moreover, given the limited stock price data available, the adjusted beta is set at 1. Also, debt and interest expense were calculated using exponential moving averages (EMA) to mitigate the impact of fluctuations. Hence, I arrived at an after-tax WACC calculation of 7.25%.

The trickier bit was estimating free cash flow (FCF) growth rates due to the company’s erratic performances over the past five years. Its FCF has experienced major fluctuations, soaring 170% in 2020 and nosediving by 88% into the negative in 2022.

Ultimately, based on last year’s EMA, I opted for a generous 25%, with a terminal value of around 3%. Based on these assumptions, BTSG stock’s fair value is $19, offering more than a 40% upside from its current price. I suspect the 25% growth rate might be too optimistic. Also, if I adjust it to around 20%, the fair value aligns closely with its IPO price of $13.

Takeaway

In totality, BrightSpring Health Services presents a mixed investment case.

It operates in a high-potential market with a healthy demand for home-based healthcare and pharmacy services. However, its financials are erratic at best, marked by slowing top-line growth, substantial debt, and volatile free cash flows. Though its stock recovered from March lows, it continues trading near its IPO price. Additionally, though my fair-value model points to a potential 40% upside, it’s based on generous growth assumptions, which may seem far-fetched at this point.

Adjusting growth expectations to a more conservative 20% aligns the stock’s fair value closer to its IPO price. Given these factors, it’s wise to approach the stock with caution and keep a close eye on it before increasing its shareholdings in your portfolios.