SIF Folio: Is Medica the investing medicine I need?

I’m pretty excited this week. I’ve got a completely new company to look at which operates in a defensive sector where the SIF fund is seriously underweight – healthcare.

I should point out that Medica (LON:MGP) floated on the LSE Main Market in 2017, so has been around for a while. But this £140m company is not one I’ve looked at before. Prior to writing this article, my knowledge of the business was limited to Graham Neary’s March 2019 SCVR report, covering Medica’s 2018 results.

I suspect some of you will have taken an interest in this company already, so please feel free to share your insights in the comments below.

What does Medica do?

Medica’s business is in ‘teleradiology’. Essentially, it provides an outsourced pool of radiologists who work remotely for the NHS, reporting on scans such as MRI, x-ray and CT scans. The group’s revenue is divided into three reportable segments:

• Nighthawk (50% revenue): emergency out-of-hours service, 24/7 response in under 60 minutes
• Routine cross-sectional scan reporting (38% of revenue): supplementing or enhancing in-house radiology expertise for CT and MRI scans
• Routine plain film (10% of revenue): Less urgent x-ray reports (I think!).
• Specialist services: revenue isn’t yet being reported for this segment, but Medica appears keen to develop expertise in areas such as specialist MRI and CT scans, nuclear medicine and DXA reporting.

The business appears to be enjoying structural growth tailwinds as NHS Trusts are faced with “growing demand for diagnostic reporting, limited in-house capacity and ongoing financial constraints”.

Medica only serves UK hospitals at the moment. According to the firm’s website, it works with more than 80 NHS Trusts. The group generated revenue of £39m in 2018, during which it reported on 1.66m “body parts”. That’s an average of £23.50 per body part, which doesn’t seem a huge amount — I guess many routine reports must be very quick to complete.

At the end of February, the company had 375 consultants on its books. These work through an IT system that gives them access to patient records. Medica undertakes to ensure that the scan workstations used by consultants are equivalent to those they’d use in an NHS hospital.

Historically, the consultants retained by Medica were all practicing UK-qualified consultant radiologists with at least two years’ NHS experience in this role. However, the company is beginning a process of internationalisation that has seen it gain agreement from the NHS to recruit overseas.

This process started last year with the recruitment of radiologists in New Zealand and Australia, who will be providing cover for UK NHS Trusts. This is expected to be the first step in a move towards becoming a global company. Discussions are also said to be underway with potential international clients.

Scanning the numbers

The story seems fairly clear. Medica started as an on-demand service to support NHS Trusts during periods of temporary shortage. The company is now taking increasing amounts of scheduled work to extend or even replace capacity within the health service. Management hope to extend this model globally.

This isn’t the place for a discussion about the merits of what appears to be creeping privatisation of the NHS. But what is clear is that Medica has delivered consistent double-digit growth and high profit margins in recent years:

These trends are expected to continue and the company scores well with the Stockopedia algorithms:

My first impressions are that this could be an interesting growth investment. Let’s find out more.

Valued for growth

You may have noticed that Medica’s ValueRank score of 30 is fairly low. This is consistent with the group’s High Flyer stock style. Stockopedia’s research has found this to be a winning style, but it does imply a premium valuation in expectation of continued growth.

Here’s how the ValueRank score breaks down:

These ratios are calculated on Medica’s historic earnings. They’re pretty much as you’d expect for a growth stock, in my view. There are just a couple of points I’d like to note.

Price/free cash flow: The P/FCF of 17.9 is a close match to the P/E of 19.1. So it looks like Medica generates plenty of cash. The accounts back this up, with net cash at the end of 2018.

Earnings yield (EBIT/EV): I like this metric for the way it combines profitability and valuation. Essentially, earnings yield is the profit margin available to the owner of a business, before tax or interest costs.

In this case, Medica’s earnings yield of 6.6% is below my usual minimum of 8%. That’s because this stock was taken from the relaxed version of my SIF screen, rather than my standard SIF screen, which is rather barren at the moment.

I’m sometimes cautious about High Flyers because of the downside risk if they stop flying… But in this case I’m comfortable with Medica’s value metrics, as long its quality and momentum scores are satisfactory.

Super quality

Medica is one of the top-ranked stocks on Stockopedia in the UK healthcare sector. One reason for this is that it has a near-perfect QualityRank of 99:

Let’s start with the franchise factors. These show consistently high profitability in terms of return on capital employed, after-tax profit margin and free cash generation.

On a purely financial level, there’s a lot to like here. But I think it’s worth taking a step back to look at the bigger picture. What do these ratios tell us about Medica’s value as a business?

What the firm does could theoretically be copied.But I feel that the company’s contractual and informal relationships with dozens of NHS trusts, plus its recruited base of (mostly) NHS consultants may be creating a network effect. This could help to protect the firm from potential rivals.

After all, the consequences of a service failure or security breach could be very serious and highly damaging to all of the organisations concerned.

Moving on, the other big highlight from the QualityRank is the Piotroski F-Score of 9/9. This fundamental health score covers areas such as profit growth, leverage and cash generation. I think it’s a great way to get a financial snapshot of a business.

You can see a detailed breakdown of a company’s F-Score by clicking through from the StockReport:

Momentum risk?

High flyers tend to score highly for momentum. That’s certainly the case here:

The only obvious weakness is at the top. At about 130p, the MGP share price is now about 24% below its 52-week high of 169p. Technical analysts might consider this a weakness, in terms of price momentum.

I think that some of this volatility may relate to the small size and relatively poor liquidity of this stock. Daily trading volumes are not particularly high:

Another possible concern is that the company’s chief executive since 2011, John Graham, is leaving at the end of August. His replacement, Dr Stuart Quin, appears to have plenty of relevant experience. But Mr Graham has been a sure hand on the wheel. His departure is bound to create some uncertainty.

The remainder of Medica’s momentum factors are as I’d hope them to be for a small cap growth stock. Earnings forecasts have edged higher over the last few months and the latest set of results were seen to be slightly ahead of forecasts.

My verdict

I can see risk as well as opportunity in Medica’s plans to expand internationally. In my view, very tight controls on service quality, IT security and recruitment standards will be needed to protect the group’s reputation.

However, these should be manageable problems, and the incoming CEO does appear to have the right kind of experience to handle this challenge.

On a financial level, I think the stock looks like a potential GARP (Growth At a Reasonable Price) stock. A forecast P/E of 15 seems a reasonable price for a company with a 24% operating margin and expected double-digit earnings growth.

Overall, I think this could be an interesting opportunity. So I will add Medica to the SIF folio and my personal holdings this week, after this article has been published.

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