We could nitpick over Virtus Health’s latest full-year result and find ‘room for improvement’ in a few financial metrics, but it would miss the forest for the trees: this was a good result and Virtus is moving in the right direction.
Though the company’s national market share fell from 37% to 36%, it was pleasing to see a strong rebound in growth, with total cycle numbers rising 6.6%, while the total number of patient treatments increased 11%.
The number of cycles performed in NSW grew an impressive 7.7%, though this wasn’t enough to keep up with overall market growth of 11%. Surprisingly, management said most of the growth came from Virtus’s full-service clinics, rather than its budget option, The Fertility Centre (TFC). This reinforces our long-standing view that Primary Health Care’s new bulk-billing IVF clinic is expanding the overall market, rather than poaching clients from Virtus (we'll get to the particulars in a moment).
Market growing strongly
Pricing pressure only affecting low-cost clinics
Diagnostic revenue posts modest growth
The strong growth in cycle numbers this year was encouraging, but the pendulum could just as easily have swung the other way. Demand for IVF has historically been volatile due to its high cost and discretionary nature, so we don’t want to get ahead of ourselves.
The number of IVF cycles and ‘frozen embryo transfers’ performed each year has grown at around 3% a year since the government reduced financial assistance in 2010 (see Virtus, Monash and the $30,000 babies). We think 3–4% market growth is a more reasonable long-term assumption than the 7% achieved this year.
What pricing pressure?
One of our biggest worries since Primary entered the market in 2014 was that its low-cost, bulk-billing clinics would put downward pressure on the price Virtus can charge for treatment, and thus squeeze the company’s margins.
So far that fear hasn’t materialised, with prices increasing 3–4% this year at most clinics, leaving the overall earnings before interest and tax (EBIT) margin roughly unchanged at a healthy 22%. Management also said that it believes a 3% a year price increase over the medium term is achievable.
|Year to June||2016||2015|| /(–)
|Net Profit ($m)||32.9||29.4||12|
|Final dividend||15 cents, fully franked, (up 7%)
ex date 15 Sept
While pricing pressure doesn’t seem to be an issue at the premium clinics, it has been a thorn in Virtus’s low-cost TFC clinics. Strong growth at regional TFC clinics – where Virtus is more likely to have a local monopoly – was more than offset by a decline in revenue at city-based TFC clinics, particularly NSW’s Liverpool clinic.
This was attributed to growing price competition from Primary. We’re pleased to see that the money-spinning full-service clinics haven’t been affected, but there’s no getting around the fact that, as far as budget IVF options go, Primary is doing something right and Virtus is being left behind.
Total revenue increased 12% to $261m thanks to acquisitions, strong growth in regional TFC clinics and a 45% increase in revenue from Virtus’s international operations. Virtus’s Irish operations performed admirably with a 24% rise in cycle numbers leading to a 33% increase in earnings before interest, tax, depreciation and amortisation (EBITDA). Virtus’s Irish business now accounts for 8% of total EBITDA and has a 40–50% share of the Irish market.
The company’s small Singapore clinic is also doing well, with a threefold increase in cycle numbers now that it is fully operational. The clinic is now profitable for the first time since it was established two years ago and it is expanding its clinical team. Management expects further improvement in EBITDA in 2017.
The only real stain on the result was that revenue from pathology and diagnostic services increased ‘only’ 5%. Management said it was due to price reductions for Virtus’s high-margin genetic screening (known as PGD). However, this was more than offset by a near doubling of volumes.
This didn’t come as a huge surprise. As we explained in Virtus Health’s genetic goldmine, PGD is a technology-intensive process and we expect it to get cheaper over time as automation and process improvements increase efficiency. And, all things considered, we prefer twice the volume of tests at half the price because PGD improves success rates, which adds value for clients and is fuel for the marketing department.
Virtus’s overall EBITDA grew 12% and free cash flow was up an impressive 35% to $38m due to lower capital expenditure. The company repaid $5m of debt, bringing net debt down to $127m. Net debt had been creeping up over the past four years, so it was nice to see an end to that trend.
With the stock trading on a price-earnings ratio of 19 and a free cash flow yield of 5.9%, Virtus isn’t expensive. However, with the share price up more than 80% since the lows hit a year ago, it may have become an unreasonably large portion of your portfolio. We recommend you gradually sell your holding if and as the share price rises to ensure you maintain a portfolio weighting below 5%. Other than that, HOLD.
Disclosure: The author owns shares in Virtus Health.