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Extendicare caught in downdraft after Medicare cuts Add to ...

Extendicare Real Estate Investment Trust felt the bite of U.S. cost savings Tuesday, as investors piled out of its shares after Washington announced an unexpectedly sharp reduction in funding for nursing homes.

The company’s shares plunged more than 18 per cent on the Toronto Stock Exchange to $8.28. Its American counterparts were also hammered, with some off as much as 50 per cent so far this week.

The U.S. Centers for Medicare & Medicaid Services (CMS) said late last week it would reduce the money it spends on nursing homes by 11.1 per cent in 2012. The dramatic cut, which takes $3.8-billion (U.S.) out of the hands of care providers, will be implemented in October.

Markham, Ont.-based Extendicare counts on funding from the CMS program to help provide medical services for the seniors who live in its homes. While the amount of funding varies each year, few expected the government to hit the brakes quite so hard.

“I think it’s safe to say that in a different year, with a different Congress, you don’t see a cut quite so severe,” said Alex Avery of CIBC World Markets.

Medicare provides about 25 per cent of Extendicare’s revenues. The company runs 176 seniors’ centres in Pennsylvania, Michigan, Wisconsin, Ohio and Kentucky and cares for about 17,000 American patients. It has 82 centres in Canada.

“These reductions to Medicare funding, which threaten to destabilize the post-acute care sector, are disappointing to say the least,” said Extendicare chief executive officer Tim Lukenda in a statement. “The ill-considered nature of the final rule and its implications for seniors and jobs are significant and immediate, particularly in light of the fragile state of the overall economy.”

Mr. Avery, who rates the shares “sector perform,” said the funding cut was made to deal with an unexpected spike in payments last year. He warned the changes could have “a very material effect” on the company’s earnings.

“We expect Extendicare units could trade weakly on this news in the near term,” he said.

The market reaction underlines the tough situation facing the U.S. economy, where steep budget cuts will be needed in order to balance the budget. Companies that rely on government funding are particularly vulnerable to cuts, as politicians look to shave $2-trillion (U.S.) in spending over the next decade as part of this week’s deal to raise the country’s debt limit.

“There’s certainly no appetite for increased spending, and there’s no way anyone is letting an opportunity to cut costs pass by,” Mr. Avery said.

Jefferies analyst Omotayo Okusanya wrote the costs are likely to be passed to the seniors who pay rent in the facilities, and the cuts were likely made to placate elected officials searching for cost savings.

“[The CMS] gave in to political pressure, given the ongoing deficit reduction talks,” he said.

RBC Dominion Securities Inc. analyst Neil Downey cut his price target to $10 from $11.50, saying the funding reduction came as a shock. Usually, the government warns of a range of options and settles somewhere in the middle. This year, it said it was considering everything from a 1.5-per-cent increase to an 11.3-per-cent reduction.

“Many (including ourselves) had been anticipating future funding adjustments,” he said. “However, the 11-per-cent reduction originally put forward was widely viewed as a starting point for negotiations with care providers. While a funding cut was expected, the magnitude and timing are worse than many had feared.”

He said Extendicare’s real estate holdings and Canadian operations shielded it somewhat from the selloff that hit its U.S. peers Monday, something the company tried to reinforce.

“We believe that Extendicare is a financially stable company with a conservative capital structure and payout ratio,” CEO Mr. Lukenda said.

“The ownership of our real estate assets, coupled with our geographic diversity, position us favourably to address these challenges. While these funding reductions will have real consequences for the way we operate our business, we are confident that we will weather this financial storm.”

Oppenheimer analyst Michael Wiederhorn also said the cuts represent a worst-case scenario for companies in the sector as he downgraded Sun Healthcare Group Inc. to “underperform.” He maintained an “outperform” rating on Skilled Healthcare Group Inc. and Ensign Group Inc.

 

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