The past six months have been a windfall for The Pennant Group’s shareholders. The company’s stock price has jumped 42.3%, hitting $41.70 per share. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is now the time to buy The Pennant Group, or should you be careful about including it in your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Is The Pennant Group Not Exciting?
Despite the momentum, we’re sitting this one out for now. Here are three reasons you should be careful with PNTG, plus one stock we’d rather own.
1. Fewer Distribution Channels Limit Its Ceiling
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 just $1.02 billion in revenue over the past 12 months, The Pennant Group is a small company in an industry where scale matters. This makes it difficult to build trust with customers because healthcare is heavily regulated, complex, and resource-intensive.
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
The Pennant Group has shown mediocre cash profitability relative to peers over the last five years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 1.9%, below what we’d expect for a healthcare business.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
The Pennant Group’s $446.5 million of debt exceeds the $4.91 million of cash on its balance sheet. Furthermore, its 6× net-debt-to-EBITDA ratio (based on its EBITDA of $77.8 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. The Pennant Group could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope The Pennant Group can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
The Pennant Group isn’t a terrible business, but it doesn’t pass our quality test. Following the recent surge, the stock trades at 28.6× forward P/E (or $41.70 per share). Investors with a higher risk tolerance might like the company, but we don’t really see a big opportunity at the moment. We’re fairly confident there are better stocks to buy right now. Let us point you toward the most entrenched endpoint security platform on the market.
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