Monash IVF: Interim result 2018
Recommendation
There wasn't a whole lot to like about Monash IVF's latest interim report – unless you're a shareholder of Virtus Health. The company had a poor six months to December in terms of cycle numbers and it lost market share in all states, though the international and pathology operations provided some good news.
A deeper shade of red was used as you move down the income statement: revenue fell 2% to $77m, earnings before interest, tax, depreciation and amortisation (EBITDA) fell 18% to $21m, and net profit fell 21% to $12m.
Key Points
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Cycle numbers down
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Margins decline in Australia; rise overseas
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7.8% free cash flow yield
The 10-ton anchor on the result was an 11% decline in fresh IVF cycles, despite the overall Australian market growing 6%. The company's national market share fell from 23% to 19%.
The loss of market share was due to a few different reasons, namely Monash converting its BUMP clinic in NSW to a premium offering, which was disruptive, as well as growth in the low-cost IVF market where Monash no longer participates (see Virtus Health: Interim result 2018). Neither of these issues is cause for concern, and we like the company's decision to focus on high-margin full-service IVF.
The resignation of Monash's highest-volume consultant and clinical director, Dr Lynn Burmeister, also reduced cycle numbers in Victoria. It didn't help that larger competitor Virtus Health completed a restructuring of its Victorian operations and increased cycle numbers 1.2%, compared to market growth of 0.3%.
Dr Burmeister's non-compete agreement ends later this year so, assuming she is up and running at a new clinic around that time, there may be a larger financial impact in 2019 if she competes for patients.
International
Monash's Malaysian operations offset some of the decline in Australia, with revenue increasing 26% thanks to a 22% increase in cycle numbers following the Kuala Lumpur clinic's relocation to a high-end facility with ample capacity. EBITDA increased 50% to $1.6m, showing off the benefits of fixed costs and operating leverage (with the drawbacks amply demonstrated in the Australian operations). Unfortunately, Malaysia only represents around 5% of Monash's total revenue, so it barely moves the needle.
The company's diagnostic and ultrasound business also performed admirably, with scan volumes up 2% and genetic screening down 6%. In business, no-one likes to see numbers going backwards, but a 6% fall is good considering that cycle numbers fell 11%, suggesting higher utilisation. Some 20% of patients now use genetic testing, more than double the rate a couple of years ago.
Six months to Dec | 2017 | 2016 | /(–) (%) |
---|---|---|---|
Revenue ($m) | 77.0 | 78.7 | (2) |
EBITDA ($m) | 20.8 | 25.3 | (18) |
NPAT ($m) | 12.1 | 15.2 | (21) |
EPS ($) | 5.12 | 6.48 | (21) |
Interim div 3.4 cents, down 21%, fully franked, ex date 8 Mar |
We're encouraged by the November appointment of David Morris to the chief executive role (see Monash IVF: bless the bumpy road). He was handed a mess and told to make something of it. Morris is only just getting started but, as Cochlear's previous chief strategy officer, he brings hope for shareholders.
Nonetheless, the company has a history of failed promises and staff issues. Three senior doctors and embryologists, as well as chief executive James Tiedemann, have resigned in the past two years – and, in 2015, a third of Monash's fertility specialists wrote a letter to the board of directors criticising company culture. The difference Morris will make is yet to be seen but Warren Buffett's advice is ringing in our ears: 'When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it's the reputation of the business that remains intact'. Time will tell.
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Management expects net profit to fall 25% in the 2018 financial year due to poor operating conditions leaking into the second half. The stock trades on a forward price-earnings ratio of around 13 and a free cash flow yield of 7.8%, so the bad news is well and truly factored into the current share price.
The stock is now trading at a material discount to our estimate of its intrinsic value, but the factors mentioned above make Monash a higher-risk proposition than Virtus, which is also on our Buy list. Virtus is the industry leader and we also favour its international expansion strategy, which focuses on well regulated, developed markets in Europe, rather than developing Asian countries.
Monash has a recommended maximum portfolio weighting of 3% compared to Virtus's 5% and we don't recommend allocating more than around 6% of your portfolio to both stocks combined. All things equal and with similar valuations, our preference is for a heavier weighting towards Virtus if you own both companies, or to favour Virtus if you have to choose between them.
Both stocks have economies of scale, excellent returns on capital, plenty of free cash flow and their balance sheets aren't stretched. As we explained in Is the IVF market splitting in two?, the market for assisted reproduction is almost certainly going to grow over the long term and the industry's two largest participants – Virtus and Monash – should keep the lion's share of profits. BUY.
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Note: The Intelligent Investor Equity Growth and Equity Income portfolios own shares in Monash IVF and Virtus Health. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.
Disclosure: The author owns shares in Monash IVF and Virtus Health.