The Ensign Group, Inc. (NASDAQ:ENSG)

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1 The Ensign Group, Inc. (NASDAQ:ENSG) ENSG - Thesis Remains Intact; Reiterate MO MARKET OUTPERFORM COMPANY UPDATE Post Acute Care - Facilities February 14, 2013 Kevin Campbell, CFA, Managing Director kcampbell@avondalepartnersllc.com Price ($) Wk Range ($) Price Target ($) (was 34.00) Market Cap ($mil) Enterprise Value ($mil) 813 Avg. Daily Vol. (000s) 69 Price / Book 2.0x AEV $890.0 Cash Per Share ($) 1.85 Net Debt / Cap. 20% Insider Ownership 16% Shares Out (mil) 21.6 Shares Short (mil) 0.5 Float (mil) 19.1 Short % of Float 2.6% Div($)/Yield(%) 0.24/0.8% Action FYE - Dec 2012A 2013E 2014E 1Q 0.61A 0.69 NE 2Q 0.67A 0.68 NE 3Q 0.62A 0.70 NE 4Q 0.61A 0.72 NE FY EPS ($) 2.49A y/y % chg 13% 12% 6% FY EPS (Old) 2.50A 2.70 NE FY EPS Consensus ($) 2.49A FY EBITDA ($mil) 128.4A FY EBITDAR ($) 141.5A FY REV ($mil) 824.6A y/y % chg 9% 8% 6% CY EPS ($) 2.49A CY P/E 12.2x 10.9x 10.2x CY EV/EBITDA 6.3x 5.6x 5.2x FY AEV/EBITDAR 6.3x 5.7x 5.3x Our thesis for The Ensign Group, Inc. (ENSG) remains firmly intact. The company is well positioned to continue its outperformance because a large portion of its portfolio (approximately 40%) has either been recently acquired or is still transitioning to a normalized run rate and it has the best balance sheet in the industry to continue to grow via acquisitions. Therefore, we reiterate our Market Outperform rating and are raising our price target to $37 (was $34), which is now based on our newly initiated 14E EBITDAR. Key Details and Summary Perspectives Pipeline Remains Solid. Management indicated that its pipeline remains full of typical ENSG deals (i.e., individual or small multi-facility deals). Competition from financial sponsors, however, appears to have increased modestly. Additionally, ENSG was not selected for any of the larger deals (e.g., KND/VTR facilities) due to price, which is consistent with SKH's experience. Positive News on Medicaid Rates. ENSG expects a 9% rate increase from Arizona that will be retroactive for part of 2012 and a net rate increase in California. Management anticipates flat rates in Utah and is hopeful it will get some relief from prior cuts in Texas due to the state's budget surplus. HH & Hospice Show Solid Growth. ENSG's home health volumes increased 56% YOY with roughly half attributable to organic growth. Similarly, its hospice volumes increased 94% YOY, with 60% of that due to organic growth. This is well above others in the industry and likely is indicative of ENSG's agencies being in the early growth stages. Urgent Care Openings Begin. ENSG's urgent care business opened its first three urgent care locations late in 2012 with two others scheduled to open in 1Q13. Positive earnings contribution is expected in 2H13 from these centers. Model Update. We are updating our model to incorporate 4Q12 results and our revised expectations. Although our 13E revenue is below guidance ($893 million v. $915-$931 million), our 13E EPS of $2.79 is at the low end of the guidance range ($2.79-$2.88). We are not assuming any benefit from the retroactive adjustment to AZ payments mentioned on the call. We also are initiating 14E EPS of $2.97, which is slightly below consensus of $3.08 and are increasing our price target to $37 (was $34). Important Disclosures on Page 4

2 Company Description Headquartered in Mission Viejo, CA, The Ensign Group (ENSG) provides skilled nursing and rehabilitative care services through the operation of 102 facilities, three hospice businesses, and four home health agencies in ten states. Facilities generally provide an array of skilled nursing services, rehabilitation therapy (physical, speech, and occupational), and other healthcare services to long-term nursing and short-term rehab patients. The Company owns 77 of its facilities and operates the remaining 25 facilities with long-term leases. It holds a purchase option on five of its leased facilities. Investment Thesis We believe that ENSG is better positioned than peers to succeed in skilled nursing. Its balance sheet positions it better for growth via acquisitions (2x Adjusted Debt-to-EBITDAR v. peers at 5-6x). In addition, approximately 40% of its beds and facilities are not part of its same-store mix compared to peers that have operated substantially the same portfolios for at least four years. This gives it more opportunities to expand occupancy, mix and margins. Lastly, it trades at the lowest multiple of EBITDAR on our 2012 and 2013 estimates. Although the industry faces continued reimbursement headwinds, ENSG is well-positioned to grow despite them, and we maintain our Market Outperform rating. Price Target Justification Our $37 price target represents a FY14 AEV/EBITDAR multiple of 6.5x. Potential Catalysts Additional Acquisitions. Ensign pursues acquisitions of underperforming, distressed assets. Within the first twelve months of operation, Ensign historically has made substantial improvements to margins, occupancy, and skilled and quality mix. Because the skilled nursing industry is highly fragmented, ENSG's leverage ratio is relatively low (~2x EBITDA), and regulatory changes are creating pressures on operators, we expect ENSG will grow via acquisitions. Our model, however, does not factor in further acquisitions. Improving Occupancy. Because of the high fixed cost nature of the business, changes in occupancy can have a meaningful impact on the bottom-line. We expect ENSG's occupancy to increase over time as it improves the operations of recently acquired assets, which represent approximately 40% of its beds. Risks Exposure to Government Payors. Medicaid and Medicare represent approximately 40% and 36% revenues, respectively. Reimbursement pressures due to strained state and federal budget deficits are likely to persist. Furthermore, regulatory changes can negatively affect operations. Geographic Concentration. California, Texas, and Arizona represent approximately 32%, 24%, and 16% of total beds (as of Dec-12), respectively. Significant changes in the reimbursement or regulatory environment in these states can have a material impact on results. Expansion into New Service Line. ENSG recently announced the expansion of its services to include urgent care clinics. The entry into a new business could present the company with unexpected challenges and distract it from its core operations. 2

3 Kevin Campbell, CFA / Managing Director / / kcampbell@avondalepartnersllc.com * INCOME STATEMENT (Millions, except EPS) Q12 2Q12 3Q12 4Q E 1Q13E 2Q13E 3Q13E 4Q13E 2013E 2014E Revenue $ $ $ $ $ $ $ $ $ $ $ $ $ $ Cost of services Facility rent - cost of services General and administrative expense EBITDA Depreciation and amortization EBIT Interest expense (5.7) (9.1) (13.8) (2.9) (3.1) (3.1) (3.1) (12.2) (3.2) (3.1) (3.1) (3.1) (12.5) (12.1) Interest income EBT Provision for income taxes Net loss attributable to non-controling interests (0.2) (0.3) (0.0) (0.5) (0.0) (0.0) (0.0) (0.0) (0.2) (0.2) Net income Basic EPS $ 1.58 $ 1.95 $ 2.27 $ 0.62 $ 0.68 $ 0.63 $ 0.63 $ 2.56 $ 0.70 $ 0.70 $ 0.72 $ 0.74 $ 2.86 $ 3.04 Diluted EPS $ 1.55 $ 1.92 $ 2.21 $ 0.61 $ 0.67 $ 0.62 $ 0.61 $ 2.49 $ 0.69 $ 0.68 $ 0.70 $ 0.72 $ 2.79 $ 2.97 Basic shares outstanding Diluted shares outstanding EBITDAR $ 86.9 $ $ $ 34.2 $ 37.0 $ 35.3 $ 35.0 $ $ 38.4 $ 38.5 $ 39.4 $ 40.6 $ $ Cost Assumptions (as % of Net Revenue) Q12 2Q12 3Q12 4Q E 1Q13E 2Q13E 3Q13E 4Q13E 2013E 2014E Cost of services 80.1% 79.5% 79.2% 79.4% 78.3% 79.4% 79.9% 79.3% 79.0% 79.0% 79.0% 79.0% 79.0% 79.0% Facility rent - cost of services 2.7% 2.2% 1.8% 1.6% 1.6% 1.6% 1.4% 1.5% 1.4% 1.4% 1.4% 1.3% 1.4% 1.3% General and administrative expense 3.8% 4.0% 3.9% 3.7% 3.7% 3.6% 3.5% 3.6% 3.5% 3.5% 3.4% 3.4% 3.4% 3.3% Depreciation and amortization 2.4% 2.6% 3.1% 3.3% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4% Tax rate 39.3% 39.3% 38.2% 38.7% 39.0% 39.0% 37.9% 38.7% 38.5% 38.5% 38.5% 38.5% 38.5% 38.5% Margins Q12 2Q12 3Q12 4Q E 1Q13E 2Q13E 3Q13E 4Q13E 2013E 2014E EBITDAR 16.0% 16.4% 16.8% 16.9% 18.1% 17.1% 16.6% 17.2% 17.5% 17.5% 17.6% 17.6% 17.6% 17.7% EBITDA 13.3% 14.2% 15.0% 15.4% 16.4% 15.4% 15.1% 15.6% 16.1% 16.1% 16.2% 16.3% 16.2% 16.3% EBIT 10.9% 11.6% 12.0% 12.0% 13.0% 12.0% 11.7% 12.2% 12.7% 12.7% 12.8% 12.8% 12.7% 12.9% EBT 9.9% 10.3% 10.2% 10.6% 11.5% 10.5% 10.3% 10.7% 11.3% 11.3% 11.4% 11.5% 11.4% 11.6% Net income 6.0% 6.2% 6.3% 6.5% 7.1% 6.5% 6.4% 6.6% 7.0% 7.0% 7.1% 7.1% 7.0% 7.2% YOY Growth Q12 2Q12 3Q12 4Q E 1Q13E 2Q13E 3Q13E 4Q13E 2013E 2014E Revenue 15.5% 19.8% 16.7% 10.5% 9.7% 5.5% 9.5% 8.8% 8.5% 7.4% 8.0% 9.3% 8.3% 6.2% EBITDAR 19.7% 22.8% 19.6% 5.6% 11.7% 5.7% 21.5% 10.8% 12.4% 4.0% 11.6% 16.1% 10.9% 6.8% EBITDA 25.2% 27.8% 23.5% 7.9% 13.1% 5.8% 25.6% 12.7% 13.9% 5.4% 14.1% 17.4% 12.6% 7.1% EBIT 21.1% 28.4% 19.9% 2.5% 10.5% 3.7% 30.3% 10.8% 14.4% 4.4% 15.4% 19.8% 13.3% 7.3% Net Income 18.1% 24.7% 17.6% 3.1% 12.2% 16.8% 30.5% 14.9% 16.2% 4.9% 16.6% 21.3% 14.6% 8.6% EPS 16.9% 23.4% 15.4% 2.4% 10.6% -1.2% 27.8% 12.8% 13.0% 2.6% 14.0% 18.4% 12.2% 6.4% 3

4 Important Disclosures makes a market in the securities and/or ADRs of The Ensign Group, Inc. ( ENSG ). and/or its affiliates, their individual officers, directors, members or employees (excluding the analyst primarily responsible for this report) and/or members of their families, may make purchases and/or sales as principal or agent in the subject securities. The analysts responsible for the preparation of this report may receive compensation which is derived, in part, from the overall investment banking revenues received by Avondale Partners. Such analysts are not permitted to receive compensation directly from investment banking fees paid by the subject company. Each Avondale Partners research analyst named on the front page of this research report, hereby certifies that (i) the recommendations and opinions expressed herein accurately reflect the analyst's personal views about the company and the securities that are the subject of this report and (ii) no part of the analyst's compensation was, or will be, directly or indirectly, related to the specific recommendations or view expressed by the analyst in this report. Price Target Valuation Method and Risk Factors: The 12 month price target is based on the analyst's assessment of future earnings and cash flow, comparable company valuations, and growth prospects. Risks to the target include broader market and macroeconomic fluctuations, as well as unforeseen changes in the company's fundamentals, business trends, competition, and/or unexpected management changes. Additional disclosures are available by calling Rating Definitions MO: Expected price gains of at least 5-10% greater than the market over the next 6-18 mos. MP: Expected price gains similar to the market over the next 6-18 mos. MU: Expected price gains of at least 5% less than the market over the next 6-18 mos. InvestmentBankingServ./Past12Mos. Rating Count Percent Count Percent BUY[MO] HOLD[MP] SELL[MU] Other Disclosures The material herein is based on sources that we consider reliable, but it is not guaranteed to be accurate or complete. It is published for informational purposes only and should not be construed as an offer, or the solicitation of an offer to buy or sell any security. Prices and opinions expressed herein are subject to change without notice, and Avondale Partners is under no obligation to update or keep the information current. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. 4

5 BANKING *** SALES *** TRADING *** RESEARCH Nashville Main West End Avenue, Ste 1100, Nashville, TN Investment Banking West End Avenue, Ste 1100, Nashville, TN Baltimore East Pratt St., Ste 321, Baltimore, MD Boston High St, Suite 702, Boston, MA Chicago N. LaSalle Street, Suite 3700, Chicago, IL Kansas City State Line Road, Suite 202, Prairie Village, KS Philadelphia Westlakes Dr., Suite 300, Berwyn, PA St. Louis City Place Drive, Suite 1060, Creve Coeur, MO