Model Portfolio rmcduff:RMG2

Advocat Inc. (nasdaq: AVCA): operates 50 nursing and assisted living centers throughout the US

The company has embarked upon a strategy to grow by building of new centers, as well as the acquisition and refurbishment of older facilities.

The firm is growing rapidly with internally generated cash flow

In the past year, the firm has increased the number of facilities under management by 16.2%, and the number of beds by 27%. Revenue has grown by 14.2% year over year.

Most of the acquired facilities had very low utilization rates and require substantial upgrades to meet Advocat standards. Renovations take about a year to complete, so there is a lag time between when the facilities are acquired, to when they start ramping up in revenue.

Revenue growth has been accelerating since 2005

I look for a 17-19% revenue growth for 2008.

2007 EBITDA was $21.7 million, up from $19.5 million generated in 2006. FFO (funds from operations) was $17.1 million for 2007, up from $14.4 million in 2006.

I am looking for $24-$25 million of EBITDA in 2008, and $20 million of FFO.

The company looks very cheap on a value basis

At year end 2007, Advocat had an enterprise value of $122.6 million. Based upon trailing multiples, Advocat is selling for 5.7X EV/EBITDA.

Based upon my 2008 forecast, AVCA is selling for 5.1X EV/EBITDA.

The shares are cheap because the firm does not issue guidance

Most investment analysts will not provide coverage unless they have company guidance to model from. The firm is not helpful, and accordingly is shunned by the street.

I consider Advocat to be one of the fastest growing small nursing home companies in the market today

By year end 2008, Advocat's revenue will surpass $300 million on an annualized basis, up by 50% in just 3 years. EBITDA will have increased by more than 100%, and the total number of beds should have doubled. The firm has already embarked upon the building of two completely new facilities for 2008, and more expansion lies ahead. With the recent slowdown in commercial construction, renovations and new builds will be cheaper than ever. Advocat could be a beneficiary of "unintended consequences" arising from the mortgage meltdown of 2007.
Based upon revenue trends, it appears that EBITDA in the next 36 months could exceed $80 million. This would be sufficient to retire all financial obligations, while maintaining business at status quo.

Alternatively, management will probably use FFO to continue a policy of methodical growth, which suggests that free cash flow will be used towards expansion of revenues.

Under either scenario, I forecast a share price in excess of $25 within 36 months. This is based upon a 2011 valuation = 5.5X EV/EBITDA.