Monash & Virtus see market growth return

This time last year, Monash IVF reported that total patient treatments in its key markets had fallen 3.7% on the prior year, compared to the 4% market growth assumed in its prospectus. Monash's share price dropped 15%, while the stock of larger competitor Virtus Health fell 8%.

However, we considered the result 'simply a short-term blip spurred by softer than expected industry figures' and maintained our Buy recommendation (see Virtus Health and Monash still buys from 30 Oct 14 (Buy – $1.37)).

Pleasingly, at yesterday's annual meeting, Monash said it has seen a reversion to average long-term market growth rates in the four months to October, with total patient treatments in its key markets growing 5.6%. Including several clinic acquisitions, the company increased total patient treatments 18.5%, boosting its Australian market share from 22% to 24%.

While the market's turnaround is certainly encouraging, demand for IVF has historically been quite volatile due to its high cost and discretionary nature. It's important we don't get too carried away – growth in cycle numbers will inevitably occur in fits and starts. One quarter's growth is pretty meaningless and this time next year we may be reporting another seizure.

Forget the short term

That's why we're focused on the long term. Couples are increasingly choosing to delay having children and as the average maternal age rises, so too does the prevalence of infertility and demand for IVF.

Since 2000, the number of treatments – IVF cycles and 'frozen embryo transfers' – per year in Australia has almost tripled, and has grown at around 4% a year since the government reduced financial assistance in 2010 (see Virtus, Monash and the $30,000 babies).

In ten years' time, there will almost certainly be more assisted reproductive procedures taking place than there are today.

We also expect larger players like Virtus, Monash, Primary Health Care and the unlisted Genea will continue to take market share from independent operators due to their economies of scale and higher research and marketing budgets.

Providers have also generally been charging more per cycle – further boosting revenue – and that trend continued last year despite Primary shaking up the industry by introducing low-cost, bulk-billing clinics (see Virtus: Result 2015). Monash's management even went so far as to say there was 'no evidence of cannibalisation of full-service business' by its own low-cost brand BUMP.

We hope that trend continues, but we expect Monash and Virtus will still find it hard to raise prices by much in the medium term. It also seems likely that the entrance of Primary will increase the competitive bidding for new clinics, making growth by acquisition more expensive.

Changes to government funding of reproductive services could have a significant impact on our long-term growth forecasts, and this increases the margin of safety we require for the two stocks. It also keeps a lid on our maximum recommended portfolio weightings, of 3% for Monash, 5% for Virtus (or somewhat less if you hold both).

Monash's management expects net profit for the first half of 2016 to increase 25%. The stock is up 14% since Monash's rising share price from 6 Nov 15 (Hold – $1.48) and it trades on a price-earnings ratio of 17. HOLD

Virtus's share price has increased 4% since Your small-cap healthcare portfolio – revisited from 16 Nov 15 (Buy – $6.30) and it trades on a price-earnings ratio of 16 despite having a superior market position. We continue to recommend you BUY.

Note: The Intelligent Investor Growth Portfolio and Equity Income Portfolio own shares in both Virtus Health and Monash IVF. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in Virtus Health.