Encompass Health (EHC)

Health care services provider Encompass Health (NYSE:EHC) met Wall Streets 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.

Company Overview

With a network of 161 specialized facilities across 37 states and Puerto Rico, Encompass Health (NYSE:EHC) operates inpatient rehabilitation hospitals that help patients recover from strokes, hip fractures, and other debilitating conditions.

The outpatient and specialty care industry delivers targeted medical services in non-hospital settings that are often cost-effective compared to inpatient alternatives. This means that they are more desired as rising healthcare costs and ways to combat them become more and more top-of-mind. Outpatient and specialty care providers boast revenue streams that are stable due to the recurring nature of treatment for chronic conditions and long-term patient relationships. However, their reliance on government reimbursement programs like Medicare means stroke-of-the-pen risk. Additionally, scaling a network of facilities can be capital-intensive with uneven return profiles amid competition from integrated healthcare systems. Looking ahead, the industry is positioned to grow as demand for outpatient services expands, driven by aging populations, a rising prevalence of chronic diseases, and a shift toward value-based care models. Tailwinds include advancements in medical technology that support more complex procedures in outpatient settings and the increasing focus on preventive care, which can be aided by data and AI. However, headwinds such as reimbursement rate cuts, labor shortages, and the financial strain of digitization may temper growth.

Encompass Health's main competitors include Select Medical Holdings (NYSE:SEM), Kindred Healthcare (private), Vibra Healthcare (private), and rehabilitation units operated within major hospital systems like HCA Healthcare (NYSE:HCA) and Universal Health Services (NYSE:UHS).

Larger companies benefit from economies of scale, where fixed costs like infrastructure, technology, and administration are spread over a higher volume of goods or services, reducing the cost per unit. Scale can also lead to bargaining power with suppliers, greater brand recognition, and more investment firepower. A virtuous cycle can ensue if a scaled company plays its cards right.

With $5.94 billion in revenue over the past 12 months, Encompass Health has decent scale. This is important as it gives the company more leverage in a heavily regulated, competitive environment that is complex and resource-intensive.

A company’s long-term performance is an indicator of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Regrettably, Encompass Health’s sales grew at a mediocre 5% compounded annual growth rate over the last five years. This was below our standard for the healthcare sector and is a rough starting point for our analysis.

Long-term growth is the most important, but within healthcare, a half-decade historical view may miss new innovations or demand cycles. Encompass Health’s annualized revenue growth of 11.2% over the last two years is above its five-year trend, suggesting some bright spots.

We can dig further into the company’s revenue dynamics by analyzing its same-store sales, which show how much revenue its established locations generate. Over the last two years, Encompass Health’s same-store sales averaged 4.9% year-on-year growth. Because this number is lower than its revenue growth, we can see the opening of new locations is boosting the company’s top-line performance.

This quarter, Encompass Health grew its revenue by 9.9% year on year, and its $1.54 billion of revenue was in line with Wall Street’s estimates.

Looking ahead, sell-side analysts expect revenue to grow 8.6% over the next 12 months, a slight deceleration versus the last two years. Still, this projection is noteworthy and indicates the market is baking in success for its products and services.

Encompass Health’s adjusted operating margin has been trending up over the last 12 months and averaged 17.2% over the last five years. Its solid profitability for a healthcare business shows it’s an efficient company that manages its expenses effectively.

Analyzing the trend in its profitability, Encompass Health’s adjusted operating margin of 17.2% for the trailing 12 months may be around the same as five years ago, but it has increased by 1.8 percentage points over the last two years.

This quarter, Encompass Health generated an adjusted operating margin profit margin of 16.1%, in line with the same quarter last year. This indicates the company’s overall cost structure has been relatively stable.

Revenue trends explain a company’s historical growth, but the long-term change in earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.

Encompass Health’s EPS grew at a spectacular 13.6% compounded annual growth rate over the last five years, higher than its 5% annualized revenue growth. However, we take this with a grain of salt because its adjusted operating margin didn’t improve and it didn’t repurchase its shares, meaning the delta came from reduced interest expenses or taxes.

In Q4, Encompass Health reported adjusted EPS of $1.46, up from $1.17 in the same quarter last year. This print easily cleared analysts’ estimates, and shareholders should be content with the results. Over the next 12 months, Wall Street expects Encompass Health’s full-year EPS of $5.46 to grow 6.1%.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Encompass Health has shown impressive cash profitability, giving it the option to reinvest or return capital to investors. The company’s free cash flow margin averaged 11.5% over the last five years, better than the broader healthcare sector.

Taking a step back, we can see that Encompass Health’s margin expanded by 3.1 percentage points during that time. This shows the company is heading in the right direction, and we can see it became a less capital-intensive business because its free cash flow profitability rose while its operating profitability was flat.

Encompass Health’s free cash flow clocked in at $235.4 million in Q4, equivalent to a 15.2% margin. This result was good as its margin was 1.7 percentage points higher than in the same quarter last year, building on its favorable historical trend.

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

Although Encompass Health hasn’t been the highest-quality company lately, it historically found a few growth initiatives that worked out well. Its five-year average ROIC was 16.7%, impressive for a healthcare business.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Uneventfully, Encompass Health’s ROIC has stayed the same over the last few years. Given the company’s underwhelming financial performance in other areas, we’d like to see its returns improve before recommending the stock.

Encompass Health reported $102.9 million of cash and $2.71 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company’s debt level isn’t too high and 2) that its interest payments are not excessively burdening the business.

With $1.27 billion of EBITDA over the last 12 months, we view Encompass Health’s 2.1× net-debt-to-EBITDA ratio as safe. We also see its $62.8 million of annual interest expenses as appropriate. The company’s profits give it plenty of breathing room, allowing it to continue investing in growth initiatives.

It was good to see Encompass Health beat analysts’ EPS expectations this quarter despite in line revenue. We were also happy its full-year EPS guidance outperformed Wall Street’s estimates, and this outlook is driving the stock up. Overall, this print had some key positives. The stock traded up 17.5% to $116.96 immediately following the results.

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in Encompass Health.

Encompass Health isn’t a bad business, but we have other favorites. Although its revenue growth was mediocre over the last five years, its growth over the next 12 months is expected to be higher. Plus, Encompass Health’s spectacular EPS growth over the last five years shows its profits are trickling down to shareholders.

Encompass Health’s P/E ratio based on the next 12 months is 17.2x. While this valuation is fair, the upside isn’t great compared to the potential downside. We're pretty confident there are more exciting stocks to buy at the moment.

Wall Street analysts have a consensus one-year price target of $141.73 on the company (compared to the current share price of $116.96).