Executive Summary / Key Takeaways

• Select Medical ($SEM) is strategically repositioning post-Concentra spin-off, focusing on its core Critical Illness Recovery, Rehabilitation, and Outpatient segments, with significant investment directed towards expanding its high-growth Inpatient Rehabilitation Hospital (IRF) division.
• While Q1 2025 results were mixed, impacted by LTACH regulatory headwinds and weather in Outpatient, the IRF segment demonstrated strong performance with 15.7% revenue growth and a robust development pipeline signaling future acceleration.
• The company's 2025 outlook anticipates revenue of $5.3B-$5.5B and Adjusted EBITDA of $510M-$530M, reflecting near-term pressures from LTACH regulations and IRF startup costs, but management expects double-digit EBITDA growth in IRF and Outpatient segments in 2026/2027 as new facilities mature and operational efficiencies take hold.
• Key challenges include navigating adverse Medicare reimbursement policies (high cost outlier threshold, 20% rule, Outpatient MPFS cuts) and managing labor costs, though agency utilization and underlying wage inflation appear to be stabilizing.
• A strong development pipeline, particularly adding 440 IRF beds by the end of 2027, coupled with investments in outpatient technology and a commitment to maintaining leverage around 3x, underpins the long-term growth thesis despite near-term volatility.

Select Medical: Reshaping the Portfolio for a New Growth Chapter

Select Medical Holdings Corporation ($SEM) stands at a pivotal juncture, having recently completed the strategic spin-off of its Concentra occupational health segment in November 2024. This move has fundamentally reshaped the company, sharpening its focus on its three core post-acute care pillars: Critical Illness Recovery Hospitals (CIRH), Inpatient Rehabilitation Hospitals (IRF), and Outpatient Rehabilitation clinics. With a history dating back to 1997, Select has established itself as a significant operator in these specialized healthcare markets across 40 states and the District of Columbia. The post-spin narrative for $SEM is now firmly centered on leveraging its established platform and pursuing targeted growth, particularly within the high-demand inpatient rehabilitation space, while navigating persistent regulatory and operational challenges inherent in the healthcare sector.

The company's strategic positioning is built upon a diversified portfolio of specialized care settings designed to meet complex patient needs following acute illness or injury. This integrated approach, spanning critical recovery to outpatient therapy, aims to provide a continuum of care. Within this structure, the IRF segment is emerging as the primary engine for future expansion, supported by a robust development pipeline and a joint venture model that facilitates capital-efficient growth. The Outpatient segment, while facing reimbursement pressures, is focused on operational optimization and technology adoption to enhance efficiency and patient access. The CIRH segment, historically a strong contributor, is currently grappling with significant regulatory headwinds that are impacting profitability.

Technological differentiation, while not defined by a single proprietary hardware like a solar panel, is increasingly a strategic focus for Select, particularly within its Outpatient Rehabilitation segment. The company has invested in and rolled out new technology in Q1 2025 aimed at improving clinical efficiency and therapist productivity. While specific quantifiable metrics on the benefits of this new system were not detailed, the stated goal is to enhance the number of patients a therapist can see in a day and improve scheduling efficiency. Management anticipates this technology will be a "game changer" and expects to see "real benefit" and "additional improvement" in therapist productivity throughout 2025 and into the new year. For investors, this focus on technology in the outpatient setting is crucial as it directly addresses labor cost pressures and aims to improve margins in a segment facing reimbursement cuts, potentially providing a competitive edge in operational efficiency.

In the broader competitive landscape, Select Medical operates alongside larger, more diversified healthcare systems and specialized providers. Key competitors include Encompass Health (EHC) in rehabilitation, and larger hospital operators like Tenet Healthcare (THC), Universal Health Services (UHS), and HCA Healthcare (HCA) which have overlapping acute and post-acute service lines. Compared to a pure-play rehabilitation provider like EHC, Select offers a more diversified portfolio, including critical illness recovery and a significant outpatient footprint. This diversification can provide resilience but also exposes the company to varied regulatory and market dynamics across segments. While larger systems like HCA and THC benefit from greater scale, potentially leading to lower operating costs per unit, Select aims to differentiate through specialized programs and integrated care pathways, which management believes can lead to better patient outcomes, such as lower readmission rates for certain conditions. However, Select's profitability margins (Net Margin TTM: 3.66%) currently lag behind some peers like EHC (Net Margin 2024: 8%) and UHS (Net Margin 2024: 7%), suggesting that while operational efficiencies are being pursued, scale and segment mix play a significant role in overall profitability. The competitive labor market remains a challenge for all providers, contributing to higher costs, though Select has seen some stabilization in agency rates and underlying wage inflation (trending at 3-3.5% as of Q2 2024).

Performance Under Pressure, Growth on the Horizon

The first quarter of 2025 provided a snapshot of Select's performance in its post-Concentra structure, revealing mixed results influenced by external factors and segment-specific dynamics. Consolidated revenue grew modestly by 2.4% year-over-year to $1.35 billion, but Adjusted EBITDA declined by 8.6% to $151.4 million, resulting in a lower Adjusted EBITDA margin of 11.2% compared to 12.5% in Q1 2024. Despite the EBITDA pressure, income from continuing operations, net of tax, saw a significant 33% increase, reaching $74.7 million.

Segment performance highlighted the divergent trends. The Critical Illness Recovery Hospital segment faced notable headwinds, with revenue decreasing by 2.9% to $637.0 million and Adjusted EBITDA dropping sharply by 25.3% to $86.6 million. Management attributed approximately two-thirds of this EBITDA decline to regulatory changes, specifically the increase in the high cost outlier threshold (which has almost doubled in two years) and the impact of the 20% transmittal rule. These factors were particularly challenging in Q1 during the peak respiratory season when the segment treats its highest acuity patients. Revenue per patient day also declined, driven by lower Medicare rates tied to these regulatory changes.

In contrast, the Inpatient Rehabilitation Hospital segment was a clear bright spot, delivering strong growth with revenue increasing by 15.7% to $307.4 million and Adjusted EBITDA rising by 14.7% to $70.4 million. This performance was fueled by increases in both revenue per patient day (+6.6% to $2,234) and patient days (+5.1% to 122,822). While overall occupancy was slightly lower (82% vs 87%) due to the inclusion of new, less mature facilities, same-store occupancy remained strong at 87%. This segment's performance underscores the strategic rationale behind the company's accelerated development efforts here.

The Outpatient Rehabilitation segment saw revenue increase by 1.4% to $307.3 million, driven by a 3% increase in revenue per visit (to $102), partially offset by a 1% decrease in total visits (attributed to one less workday in the quarter). However, Adjusted EBITDA for the segment declined by 2.6% to $24.3 million, and the margin decreased to 7.9% from 8.2%. This was primarily due to higher labor costs and the estimated $4 million impact from severe weather events in the South and Central regions. Management noted that the segment would have exceeded prior-year EBITDA without the weather impact and that it finished Q1 strongly, with positive momentum carrying into Q2.

Financially, Select ended Q1 2025 with $53.2 million in cash and $1.8 billion in total debt. The company's refinancing in December 2024, which included new term loans (SOFR+2%) and senior notes (6.25% due 2032), reduced overall debt and lowered interest expense compared to the prior year ($29.1 million in Q1 2025 vs $40.7 million in Q1 2024, also benefiting from a prior year interest rate cap gain). Net leverage for the senior secured credit agreement stood at 3.4 times at March 31, 2025.

Operating cash flow used $3.5 million in Q1 2025, a significant improvement from $66.7 million used in Q1 2024, primarily due to the normalization of accounts receivable following the Change Healthcare cyber incident. The company maintains $377.5 million in availability under its revolving facility and utilizes an interest rate cap on $1 billion of its term loan to mitigate exposure to rising variable rates. Capital allocation priorities include development, stock repurchases (repurchased $11.4 million in Q1 2025), and dividends ($0.06 declared in April 2025).

The strategic emphasis on the IRF segment is evident in the development pipeline. Select plans to add 440 beds from Q2 2025 through the end of 2027, predominantly in rehabilitation hospitals and units, including joint venture projects with partners like UPMC, Cleveland Clinic, Banner, and Cox Health. Management expects these new facilities, particularly those under the joint venture model, to mature relatively quickly and drive significant double-digit EBITDA growth in the IRF segment in 2026 and 2027. Opportunities to expand the CIRH footprint are also being evaluated, favoring the less capital-intensive hospital-within-a-hospital model. In Outpatient, strategic closures and consolidations (13 locations in Q1 2025) alongside de novo openings (10 in Q1 2025) aim to optimize the portfolio.

Outlook and Key Considerations

Select Medical's slightly adjusted 2025 business outlook anticipates revenue between $5.3 billion and $5.5 billion and Adjusted EBITDA between $510 million and $530 million. Adjusted earnings per common share is expected to be in the range of $1.09 to $1.19. Capital expenditures are projected at $160 million to $200 million. This guidance reflects the mixed performance in Q1, incorporating the impact of LTACH regulatory pressures and Outpatient weather events, while banking on continued strength and maturation in the IRF segment and operational improvements in Outpatient.

Management's commentary suggests expectations for relatively stable margins in the LTACH segment for 2025, with operators continuing to manage through the outlier threshold increases. The Outpatient segment is expected to see double-digit EBITDA growth in 2025 and 2026, driven by technology-led efficiency gains and favorable commercial rate negotiations offsetting Medicare cuts (expected 3% reduction in 2025 MPFS). The significant IRF development is projected to keep consolidated margins somewhat constrained in 2025 due to startup costs but is the primary driver for anticipated double-digit EBITDA growth in that segment in 2026 and 2027.

Key risks to the outlook include the ongoing impact of Medicare reimbursement policies, particularly for LTACHs, where proposed rules for FY2026 include further outlier threshold increases despite a proposed base rate increase. The change in LTCH outlier reconciliation criteria could also lead to more recoupments. Litigation and governmental investigations, such as the ongoing Oklahoma City and Physical Therapy Billing matters, pose potential financial and reputational risks. Macroeconomic factors like inflation and labor market tightness continue to influence operating costs.

Conclusion

Post-Concentra spin, Select Medical is charting a course focused on its specialized hospital and outpatient services, with the Inpatient Rehabilitation segment positioned as the key growth engine. While Q1 2025 highlighted the vulnerability of the Critical Illness Recovery segment to adverse regulatory changes and the Outpatient segment to external shocks like weather, the robust performance and significant development pipeline in IRF underscore the company's strategic pivot. The 2025 outlook balances near-term operational and regulatory headwinds with the anticipated benefits of new IRF capacity coming online and efficiency initiatives in Outpatient, supported by technology investments. Investors should monitor the execution of the IRF development plan, the effectiveness of operational improvements in Outpatient, the impact of ongoing LTACH regulatory dynamics, and the company's ability to manage labor costs and leverage its diversified model to drive future profitability and cash flow generation. The narrative is one of strategic transformation, betting on specialized post-acute care growth to offset pressures in other areas and unlock long-term value.