Why we still like Virtus Health

There are short term risks, but Virtus is banking on more women using their service over the coming years.

According to a study conducted by the University of New South Wales, only 18 per cent of the nearly 72,000 assisted reproduction treatment cycles in 2013 in both Australia and New Zealand resulted in a live birth.

Odds of one in five might not sound that great, particularly when an IVF cycle, one form of assisted reproduction, costs around $9,000 (before Medicare and private health insurance contributions).

Yet if you’re one of the increasing number of women who have postponed starting a family to concentrate on your career, considering the odds and cost involved is secondary to your desire to have children.

Combined with a dominant market position and the ability to sell high-margin add-ons – after paying many thousands of dollars for an IVF cycle, who’s going to argue against paying an additional $150 for an embryonic glue that may (or may not) increase your odds of impregnation? – this makes Virtus Health a very good business.

Economies of scale

Setting up an IVF clinic is relatively inexpensive but companies such as Virtus Health (VRT), listed competitor Monash IVF (MVF) and unlisted Genea benefit from economies of scale and their higher research and marketing budgets than their independent competitors.

Fertility specialists are highly trained and, with only around a dozen or so new ones graduating each year, they could potentially take much of the profit from the assisted reproduction business. Virtus mitigates this risk by signing up fertility specialists on five year contracts plus options, although there remains the risk that it will be forced to pay more for their services or lose them to competitors come contract renewal time.

For their part, fertility specialists benefit from being part of the Virtus network, which also includes Specialist Diagnostics and Day Hospital segments.

Get what you pay for

For most companies, the entry of a competitor that competes on price is potentially a big threat to their profits. No doubt there will be some pressure on margins as bulk-billed IVF operator Primary Health Care (PRY) builds up its business – the out of pocket expense for Primary’s customers amounts to around $500 compared to around $2,500 for Virtus’s full-service business – but in IVF you get what you pay for.

To save on costs, Primary uses a local rather than general anaesthetic and less hormones to stimulate egg production, meaning it collects fewer eggs than in a full-service offering from the likes of Virtus. The chances of all those eggs being fertilised, surviving and being available for implantation are low. If the embryo fails, you have to start again.

In contrast, the full service operators utilise genetic screening to choose the best eggs, thereby increasing the chances of implantation. Moreover, surplus eggs can be frozen and, if necessary, used later, which reduces the cost – and stress – of any subsequent cycle required if the original cycle fails.

As such, the low-cost option may initially seem less expensive but the odds are that over the long term, on average it will actually be more expensive than the full service version. Moreover, when couples are desperate for a baby, they’re less likely to skimp on cost if paying up increases their odds of starting a family.

As colleague James Samson noted here: Steadfast looks strong while Virtus grows, February 19, 2016, it appears that Primary Health Care’s entry has expanded the market rather than seriously threatening the full-service operators like Virtus. Moreover, Virtus’s low-cost The Fertility Centre business will help it compete with Primary Health Care for customers who appear unlikely to have complications that would require a fuller service.

Of more concern to me is further reductions in government subsidies. Despite the benefits to the economy – and the budget – of an increasing population, Australia’s precarious budget position means there is the risk that a government looking for savings will reduce Medicare subsidiaries, particularly if they continue to increase along with demand for assisted reproduction services.

Bumpy demand

Over the short term, demand for IVF can be volatile due to its high cost and discretionary nature but demand is likely to steadily increase over the longer term. The rising percentage of women postponing having children to climb the corporate ladder, their consequent increased ability to pay for assisted reproduction, population growth, and the rising instances of obesity and chlamydia (which make pregnancy more difficult) all point to increasing demand for assisted reproduction over the longer term.

All these influences are positive for Virtus Health and, as noted above, the threat from low-cost competition, while real, is more likely to grow the market than seriously dent the company’s fortunes. We would consider downgrading it to Hold above $7. For the moment, though, it remains a Buy.

Disclosure: the author owns shares in Virtus Health

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