Shareholders of Acadia Healthcare would probably like to forget the past six months even happened. The stock has dropped 39.1% and now trades at a new 52-week low of $14.31. This was partly driven by its softer quarterly results and might have investors contemplating their next move.
Is there a buying opportunity in Acadia Healthcare, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free for active Edge members.
Why Is Acadia Healthcare Not Exciting?
Despite the more favorable entry price, we're cautious about Acadia Healthcare. Here are three reasons why ACHC doesn't excite us and a stock we'd rather own.
1. Weak Sales Volumes Indicate Waning Demand
Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Hospital Chains company because there’s a ceiling to what customers will pay.
Acadia Healthcare’s admissions came in at 54,450 in the latest quarter, and over the last two years, averaged 2% year-on-year growth. This performance slightly lagged the sector and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability. 
2. Shrinking Adjusted Operating Margin
Adjusted operating margin is one of the best measures of profitability because it tells us how much money a company takes home after subtracting all core expenses, like marketing and R&D. It also removes various one-time costs to paint a better picture of normalized profits.
Analyzing the trend in its profitability, Acadia Healthcare’s adjusted operating margin decreased by 5.2 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its adjusted operating margin for the trailing 12 months was 13.6%.
3. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Acadia Healthcare’s margin dropped by 21.7 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. Almost any movement in the wrong direction is undesirable because it’s already burning cash. If the longer-term trend returns, it could signal it’s becoming a more capital-intensive business. Acadia Healthcare’s free cash flow margin for the trailing 12 months was negative 10.6%.
Final Judgment
Acadia Healthcare isn’t a terrible business, but it doesn’t pass our quality test. After the recent drawdown, the stock trades at 6.6× forward P/E (or $14.31 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We're pretty confident there are superior stocks to buy right now. We’d recommend looking at our favorite semiconductor picks and shovels play.
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