Executive Summary / Key Takeaways

• Encompass Health Corporation (EHC) is strategically expanding its leading inpatient rehabilitation hospital (IRF) network to meet the growing, underserved demand from an aging U.S. population, driving consistent revenue and EBITDA growth.
• The company's operational excellence is evident in strong patient outcomes, favorable labor management trends, and the effective integration of technology, including AI-driven tools, to enhance efficiency and quality.
• EHC's disciplined capital allocation prioritizes high-return capacity expansions, particularly bed additions to existing hospitals, alongside a robust de novo pipeline, supported by strong free cash flow generation and a flexible balance sheet.
• Despite a highly regulated environment and persistent labor market challenges, EHC's competitive advantages, including its extensive network and integrated care model, position it for sustained market share gains.
• The company's raised 2025 guidance reflects confidence in its strategic execution and the favorable impact of recent regulatory updates and tax provisions.

A Foundation of Specialized Care and Strategic Expansion

Encompass Health Corporation, a leader in inpatient rehabilitation services, has carved out a dominant position as the nation's largest owner and operator of inpatient rehabilitation hospitals (IRFs). The company's core mission revolves around providing specialized rehabilitative treatment for patients recovering from complex medical conditions such as strokes, neurological disorders, brain and spinal cord injuries, and complex orthopedic conditions. This focus positions EHC at the nexus of a critical and growing healthcare need.

The broader industry landscape is characterized by a significant and expanding demand for post-acute rehabilitation services, primarily fueled by the aging U.S. population. The Medicare beneficiary demographic, which EHC predominantly serves, is the fastest-growing segment in the country, with projections indicating over 70 million Americans aged 65 or older by 2030. This demographic trend translates into a consistent CAGR of approximately 3% for the 65-or-older population, and an even higher 4% for those aged 75 and above. Despite this surging demand, the supply of licensed IRF beds across the U.S. has seen only nominal growth over the past decade, creating a substantial and increasingly critical supply-demand imbalance. This fundamental market dynamic forms the bedrock of EHC's compelling investment thesis.

EHC's strategic response to this unmet need is a disciplined and aggressive capacity expansion program, leveraging both de novo hospital developments and high-return bed additions to existing facilities. The company's historical journey, from its incorporation in 1984 as HealthSouth to its rebranding in 2018, underscores a continuous evolution towards its current integrated care model. A pivotal moment for EHC's growth strategy occurred in April 2020, when it proactively accelerated its de novo program, notably acquiring land in Florida to capitalize on market opportunities that emerged after the state lifted its Certificate of Need (CON) restrictions in 2021. This foresight allowed EHC to establish a first-mover advantage and build significant market density in key regions.

Technological Edge in Clinical Outcomes and Efficiency

Encompass Health differentiates itself through an extensive application of technology, which is foundational to its competitive strength and operational effectiveness. The company's technological differentiators are not merely about adopting new tools but about integrating them to drive superior clinical outcomes and enhance operational efficiency.

EHC utilizes advanced predictive analytics and AI-driven tools to optimize patient care and streamline administrative processes. For instance, the company's fall risk model, implemented in 2020, has led to a tangible 30% improvement in fall rates, directly enhancing patient safety and recovery. Similarly, the REACT model, developed in 2015 for acute care transfers, has shown a 24% improvement in efficiency by 2020. These models leverage data from numerous clinical elements to inform clinicians, allowing for proactive interventions and improved patient management. The "so what" for investors is clear: these technologies contribute to EHC's reputation for high-quality care, which in turn attracts referrals and strengthens its market position.

Beyond clinical applications, EHC employs AI to reduce administrative burdens on its staff. Nurse liaisons, for example, use AI-powered tools on iPads for patient evaluations, reducing documentation time by 20 minutes per assessment. This efficiency gain, when scaled across the organization, significantly improves staff productivity and job satisfaction, which is crucial in a competitive labor market. On October 3, 2025, EHC completed a comprehensive conversion of its ERP system to Oracle Fusion, a significant technological upgrade aimed at enhancing workflow efficiencies across all finance, accounting, supply chain, and HR functions. While not tied to a specific ROI, this foundational system upgrade is expected to further streamline operations and support future growth. These technological investments underscore EHC's commitment to innovation that directly translates into operational leverage and a stronger competitive moat.

Competitive Landscape and Strategic Positioning

Encompass Health operates in a highly competitive and regulated healthcare environment, yet it maintains a strong market position as the largest IRF operator. Its primary direct competitors include Select Medical Holdings Corporation (SEM), Amedisys, Inc. (AMED), UnitedHealth Group Incorporated (UNH) (via its LHC Group segment), and Brookdale Senior Living Inc. (BKD).

EHC's competitive strategy is anchored in its integrated care model and extensive national network, which includes 170 hospitals across 39 states and Puerto Rico as of September 30, 2025. This broad footprint allows EHC to offer comprehensive post-acute care, emphasizing seamless transitions between inpatient and home-based services. Compared to Select Medical, which also has an aggressive expansion strategy in rehabilitation, EHC differentiates itself through its consistent focus on high-quality clinical outcomes and cost-effectiveness, leveraging its technological advancements. While Select Medical may pursue rapid scaling, EHC's disciplined approach to bed additions, which offer the highest return on invested capital, ensures sustainable growth.

Against Amedisys and UnitedHealth Group's LHC segment, both strong in home health, EHC's unique value proposition lies in its specialized inpatient rehabilitation expertise. EHC's patient-focused services often provide superior continuity of care compared to UNH's broader, insurance-driven model. While AMED and UNH may lead in pure technological agility for remote monitoring or data analytics, EHC's integrated model and facility network foster stronger patient retention and allow for comprehensive service bundling, enhancing its pricing power. EHC's ability to treat medically complex, higher-acuity patients, such as those recovering from strokes and brain injuries, further distinguishes it from providers like skilled nursing facilities (SNFs) and even some acute-care hospitals, which often refer patients to EHC. The company has consistently gained market share, with ten consecutive quarters of same-store discharge growth above 4%, indicating successful capture from other post-acute providers.

High barriers to entry, including substantial capital outlays (approximately $1.2 million per bed for new hospitals and $800,000 per bed for bed additions), clinical complexity, and stringent regulatory requirements, protect EHC's market position. These factors make it difficult for less capitalized or experienced players to compete effectively. EHC's "first-mover advantages" and "speed to market," supported by internal real estate and design/construction teams, are critical in new markets and states where CON restrictions are lifted, such as Florida. The company is also exploring "small-format hospitals" (roughly 24-bed units) for flexible expansion and market diversification.

Robust Financial Performance and Liquidity

Encompass Health has demonstrated strong financial performance, reflecting its effective strategy and operational execution. For the third quarter ended September 30, 2025, net operating revenues increased by 9.4% to $1,477.50 million, contributing to a year-to-date revenue growth of 10.6% to $4,390.60 million. This growth was primarily driven by a 5% increase in total discharges and a 3.3% increase in net revenue per discharge during Q3 2025. Same-store discharge growth, a key indicator of organic strength, was 2.9% in Q3 2025.

Adjusted EBITDA, a critical measure of operational profitability, grew by 11.4% to $300.1 million in Q3 2025 and 14.5% year-to-date to $932.30 million. This performance was supported by favorable labor management trends. Salaries and benefits per full-time equivalent (SWB per FTE) increased modestly by 2.6% in Q3 2025, while premium labor costs (contract labor and sign-on/shift bonuses) decreased by $5.6 million from Q3 2024 to $27 million. The company's employees per occupied bed (EPOB) ratio was 3.42 in Q3 2025, reflecting efficient staffing levels, though management aims for a 3.4 target, acknowledging fluctuations due to new capacity additions. Benefits expense per FTE increased by 1.9% in Q3 2025, moderating as the company anniversaried higher group medical claims from the prior year.

Liquidity remains robust, with net leverage at 2.0x at the end of Q3 2025. The company held $48.70 million in cash and cash equivalents, along with $45 million in restricted cash and $139.80 million in restricted marketable securities. A substantial $873 million was available under its revolving credit facility. EHC's capital structure is designed for flexibility, with no significant debt maturities until 2028. The company actively manages its capital, as evidenced by the redemption of $100 million of its 5.75% Senior Notes due 2025 in September 2025, using cash on hand and credit facility capacity.

Adjusted free cash flow for Q3 2025 was $174.2 million, a decrease of 8.2% due to a $55.8 million increase in working capital related to accelerated payments for the Oracle Fusion ERP conversion. However, year-to-date adjusted free cash flow increased by 16.5% to $582.5 million. The company's capital allocation strategy prioritizes capacity expansions, which offer the highest returns. With strong free cash flow generation and declining leverage, EHC has increased its capacity for shareholder distributions, including share repurchases and dividends, with a quarterly dividend of $0.19 per share declared in October 2025.

Outlook and Growth Initiatives

Encompass Health's outlook for sustained growth is optimistic, underpinned by its strategic initiatives and favorable market dynamics. The company has raised its full-year 2025 guidance, projecting net operating revenue between $5.905 billion and $5.955 billion, adjusted EBITDA between $1.235 billion and $1.255 billion, and adjusted earnings per share (EPS) ranging from $5.22 to $5.37. The full-year adjusted free cash flow estimate was also increased to $730 million to $810 million.

A key driver of future growth is the aggressive expansion of its bed capacity. EHC expects to add approximately 127 beds to existing hospitals in 2025, and a further 150 to 200 beds in both 2026 and 2027. This multi-year expansion, driven by rising occupancy rates and unmet demand, represents a significant capital deployment into high-return projects. The company's de novo pipeline remains robust, with 14 announced new hospitals beyond 2025, totaling 690 beds, and an active pipeline of over 40 projects. EHC is expanding into new states like Connecticut (with a 40-bed hospital opened in Danbury in September 2025) and planning future entries into Utah and Nevada, alongside continued density in existing strong markets like Florida and Texas.

Regulatory developments also contribute to the positive outlook. The 2026 IRF Final Rule is expected to result in a net increase of approximately 2.9% to Medicare payment rates, effective October 1, 2025. Additionally, the One Big Beautiful Bill Act (OBBBA), signed in July 2025, is estimated to generate approximately $50 million in cash tax savings for EHC in 2025, primarily through bonus depreciation and R&D expensing provisions. Management anticipates that the current operating environment, characterized by controlled labor costs and sustained demand, will continue to be favorable into 2026.

Risks and Challenges

Despite the positive outlook, Encompass Health faces several pertinent risks. The company's high concentration in the inpatient rehabilitation business makes it particularly sensitive to changes in Medicare regulations and reimbursement policies. The Inpatient Rehabilitation Facility Review Choice Demonstration (RCD) program, which expanded to states like Alabama and Pennsylvania, poses a risk due to inconsistent review processes by Medicare Administrative Contractors (MACs), potentially impacting the collectability of Medicare claims. EHC has actively engaged with MACs and CMS to ensure fair treatment, but the unpredictability remains a challenge.

Labor market dynamics, including the ability to attract and retain qualified nurses, therapists, and other healthcare professionals in a competitive environment, continue to be a key challenge. While EHC has shown strong labor management, staffing shortages could lead to increased labor costs and constrain patient intake. The pre-authorization process, particularly with Medicare Advantage plans, remains challenging, characterized by lower admit-to-referral ratios and longer decision times compared to fee-for-service Medicare. EHC advocates for regulatory changes, such as requiring MA plans to include IRFs in network adequacy definitions, to address these issues. Furthermore, the broader healthcare industry faces ongoing efforts to transform care delivery and payment models, introducing regulatory uncertainty that EHC must adapt to.

Conclusion

Encompass Health Corporation stands as a compelling investment opportunity, firmly rooted in the demographic tailwinds of an aging population and the persistent, unmet demand for specialized inpatient rehabilitation services. The company's disciplined strategy of capacity expansion, driven by high-return bed additions and a robust de novo pipeline, ensures it is well-positioned to capture this growing market. EHC's operational excellence, underpinned by its integrated care model and a commitment to technological differentiation through AI-driven clinical and administrative tools, translates directly into superior patient outcomes and enhanced efficiency.

The company's strong financial performance, marked by consistent revenue and EBITDA growth, coupled with a flexible balance sheet and increasing free cash flow, provides the capital necessary to fund its ambitious growth initiatives and return value to shareholders. While regulatory complexities and labor market pressures present ongoing challenges, EHC's established competitive advantages—its extensive network, specialized expertise, and proven ability to adapt—fortify its market leadership. EHC's proactive approach to expansion and innovation, combined with its focus on delivering high-quality, cost-effective care, positions it to continue its growth trajectory and deliver long-term value for discerning investors.