EHC Q4 Deep Dive: Labor Cost Control and Capacity Expansion Drive Outperformance

Health care services provider Encompass Health (NYSE:EHC) met Wall Street’s revenue expectations in Q4 CY2025, with sales up 9.9% year on year to $1.54 billion. The company’s outlook for the full year was close to analysts’ estimates with revenue guided to $6.42 billion at the midpoint. Its non-GAAP profit of $1.46 per share was 12.1% above analysts’ consensus estimates.

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StockStory’s Take

Encompass Health’s fourth quarter was marked by strong operational execution, with management attributing the positive results to disciplined labor cost management and continued growth in patient discharges. CEO Mark Tarr highlighted that premium labor spend declined by over $21 million year over year despite significant capacity additions and an increase in patients treated. The company also noted that patient outcome and quality metrics outperformed industry averages, supported by investments in both new hospitals and expanded bed capacity. Management credited these operational efficiencies and quality improvements as key drivers of the quarter’s performance.

Looking ahead, management’s guidance is shaped by expectations for continued growth in the company’s target demographic and ongoing investments in new hospital formats. CEO Mark Tarr emphasized the company’s strategy to address regulatory changes, stating, “We have a long track record of successfully adapting and continuing to grow as the underlying demand for IRF services continues to grow.” Management is also banking on further operational leverage, expansion into small-format hospitals, and expanded use of clinical technology partnerships as drivers for the coming year.

Key Insights from Management’s Remarks

Management focused on cost control, patient mix, and regulatory preparedness as central themes for the quarter’s performance and future trajectory.

• Labor cost improvements: Leadership reported a notable reduction in premium labor costs, attributing it to lower contract labor use and improved nurse retention, reaching pre-pandemic turnover levels. This was achieved while adding capacity through new hospital openings, reflecting effective hiring and operational discipline.
• Discharge growth and patient mix: Growth in overall patient discharges was driven by increased volume in diagnosis categories like brain injury, cardiac, and neuro cases. Management noted that Medicare fee-for-service mix strengthened, which is the company’s most profitable payer class, while some challenges persisted in Medicare Advantage conversion rates.
• Capacity expansion: The company added 517 beds through eight new hospitals and expansion of existing facilities. Management also unveiled plans to introduce small-format hospitals beginning in 2027, aiming to enhance market penetration and operational flexibility in densely populated or capacity-constrained markets.
• Regulatory adaptability: Addressing regulatory concerns, management cited successful engagement with CMS and favorable affirmation rates in Alabama under the Review Choice Demonstration (RCD) process. Experience in regulatory pilots and willingness to pursue legal avenues against Medicare Advantage denials were highlighted as strengths.
• Technology partnership progress: The ongoing collaboration with Palantir has yielded administrative efficiencies, particularly in admission documentation and claims denial management. Management expects further benefits as the partnership expands to areas like market analysis and clinical staffing optimization.

Drivers of Future Performance

Encompass Health anticipates that continued demographic growth, capacity additions, and strategic responses to regulatory changes will be key themes in its outlook for the next year.

• Demographic-driven demand: Management expects underlying growth in the aging population to sustain demand for inpatient rehabilitation, supporting ongoing investments in new capacity, including small-format hospitals tailored to specific market needs.
• Regulatory headwinds and mitigation: The company faces regulatory changes such as the TEAM payment model and extension of RCD reviews but believes its experience with similar models and proactive engagement with CMS will help mitigate potential volume and reimbursement impacts. Management also plans to address payer challenges through admit-and-appeal strategies for Medicare Advantage denials.
• Operational efficiencies: Leadership is prioritizing further improvements in labor management and technology-enabled administrative processes. The expanded partnership with Palantir and continued focus on staff retention are expected to drive additional cost savings and operational leverage.

Catalysts in Upcoming Quarters

In coming quarters, the StockStory team will be monitoring (1) execution of the small-format hospital strategy and the pace of capacity additions, (2) the company’s ability to manage regulatory transitions, especially with the TEAM model and RCD expansion, and (3) the effectiveness of operational improvements in labor management and technology adoption. Shifts in payer mix and volume growth by diagnosis category will also be important to track.

Encompass Health currently trades at $107.77, up from $99.56 just before the earnings. At this price, is it a buy or sell? Find out in our full research report (it’s free).

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