PRVA - Privia Health: Unit Economics Stretching Higher At Qualified Growth Rates (Rating Upgrade)

2023-08-16 22:55:55 ET

Summary

• Privia Health Group, Inc. shows growth in key business metrics and can unlock risk capital for equity investors this year.
• Q2 financials demonstrate top-line growth, gross margins, and critical unit economics.
• The company's asset-light business model drives economic value and supports an upside view on market value in my view.
• Net-net, revise to buy.

Investment briefing

After extensively reviewing the investment case for Privia Health Group, Inc. ( PRVA ) findings corroborate a revised buy rating in my view. Following the September FY'22 publication on PRVA, several pointers suggest the company can unlock risk capital for equity investors this year. PRVA exhibits growth in key business metrics underlying its unit economics, growing attributable lives by 335,000 these past 3 years, along with $750mm in practice collections and ~1,500 in providers. Further, it is recycling decent amount of cash flows off an asset-light business model and redeploying this back into operations. Net-net, I revise PRVA to a buy, eyeing $32/share as the initial price objective.

Figure 1. PRVA price evolution

Critical investment facts forming buy thesis

The investment debate is solidified by three primary factors in PRVA's case in my view—fundamental/economic factors (asset-light earnings growth), sentiment, and valuation. The case is outlined below.

1. Q2 financials—clear upsides in core business

Analysis of the firm's latest numbers exhibits a trajectory of growth and operational efficiency. I've summarized the 5 major data points in numerical order below:

1. Top-line growth and gross margins : Total revenue came to $413.4mm, up 23.2% YoY from $335.5mm. This remarkable revenue growth signifies the company's robust market presence and effective operational strategies. It pulled this to gross of $90.2mm, a gain of ~$15mm YoY. Growth was underscored by performance across all segments. For the YTD, turnover came to $799mm, with patient care driving the bulk of this with $458mm booked at the top line.

Figure 2. H1 revenue clip, each year from 2020

2. Cash flow backing revenue : It pulled this to quarterly operating income of $7mm on OCF of $7.6mm, a c.2% cash flow margin. The bulk of cash 'outflows' are booked as changes in accounts receivable, as the firm ramps up turnover and books more revenues forward from key customers. What's important in my view is the cash conversion from operating income is high, but also the unit economics backing these cash flows and receivables is stretching higher.

4. Provider Expansion : Critically, the unit economics driving sales and cash flows are a driving growth for PRVA. For one, implemented Provider count was 9.3% totalling 3,870 for the quarter. Stepping back on this and you see the growth in these key metrics since 2020 [Figure 3, using H1 numbers each year]. Providers have increased by 1,519, attributed lives are up 335,000 to 1.08mm, and practice collections have increased ~$750mm over the last 3 years. This qualifies PRVA as a growth name in my view and suggests further momentum from its unit economics going forward. Management forecast 1.15 attributed lives by yearend, on $2.8Bn in practice collections, and 4,150 implemented providers. You can see the care and platform contributions below as well, noting the doubling of growth in each from H1 FY'20–H1 FY'23. These are constructive points in my view.

Figure 3.

5. Strategic pivot to value-based care : As an extension of point (4), Q2 saw value-based care contribute 37% of the top line, a notable increase from the 29.6% booked last year. This is a strategic transition in my view. In particular, it underlines PRVA's growth in at-risk contracts and fits with the growth numbers outlined earlier. You see this in the firm's broad offering. The 1.08mm attributed lives are claimed across >100 at-risk payer contracts. The 27% YoY growth in attributed lives outlined earlier is also key evidence PRVA's strategy is working here as well.

2. Economic value created for shareholders

There are several advantages to PRVA's operating model that make it attractive within my equity budget. For one, it is an asset-light model that produces reasonable cash flows off capital deployed. This has resulted in a tidy sequential increase in net asset value per share and cash per share. You've got book value/share up from $3.70 since listing to $4.50/share, whereas it now boasts >$2.70 in cash per share.

Figure 4.

Investors have provided the firm with $525mm in capital (all equity financed) and PRVA has put 102% of this at risk into growing the business. Stripping out the cash on hand, it has only put 42% to work, the remainder tied up in marketable securities. Not the worst idea, with cash yielding 4–5% these past 2 years. The cash also gives PRVA the optionality to deploy when needed and just about covers all non-interest-bearing liabilities in the current account.

Figure 5.

PRVA earned $39.5mm in trailing OCF on this $537mm and recycled ~19% of cash flow back into the business to fund its growth initiatives for the remainder of FY'23. It also made ~$15mm in new capital commitments to produce the $39.5mm in cash flow, otherwise a 2.6% margin as outlined earlier. Critically, the firm also spun of ~$17.3mm in cash to its owners (TTM values) by the end of the quarter.

Figure 6.

Critically, the cash flow return on investments ("CFRoI") has yielded 7.4% in the TTM, but pushes to 18% extracting cash on hand from the invested capital calculus. The firm's strengths lie in its capital efficiency, where it looks to employ a cost differentiation strategy, turning over its investments 2.8x over the TTM. This is in synch with historical range. The differentiation strategy implies it is seeking competitive advantage by pricing its services/offerings below the industry average—makes sense in my view, given the many conversions of attributed lives on a rolling basis. This means it can focus on driving upside at the post-tax margin and potentially increase profitability beyond what's seen here.

Moreover, at 18% trailing CFRoI, you're looking at incremental investment returns of 2.7%, which is accretive to the company's valuation. What this analysis tells me is that:

1. PRVA's asset-light business model drives economic value through the efficient use of capital to produce cash flows;
2. These cash flows are recycling back to PRVA at ~18%— up to28% on average over the last 3 years (TTM values);
3. This enables the company to redeploy cash at these rates of return to compound the intrinsic value of the business.

These are attractive economics in my view and support an upside view on the company's market value, which is likely to track its business returns over the long run.

Figure 7.

Valuation

To value PRVA several points are taken into consideration. One is the long-term view of price visibility and objective technical targets. You can see in Figure 8, the daily cloud chart, both the price line and lagging line (in blue) are positioned above the cloud. Critically, it has been testing the cloud as support since July, having bounced from the base a number of times. It tells me the stock finds support even when it sells at these key psychological levels. That both lines are above the cloud is bullish to me, and the daily chart looks to the weeks ahead.

Figure 8.

Moreover, we have upside targets to $32 and $37.5 on the point and figure studies below. These cancel the noise of time and provide a more objective view of price visibility by removing intra-trend volatility. Mathematical formulae are then used to derive the price targets based on a multi-faceted slew of market data. That we have upsides to the $30's is bullish to me, and a break higher could see us head to $32. This is my initial objective.

Figure 9.

PRVA's economic factors also play into the valuation calculus here. The stock sells at 1.8x forward sales as I write, attractively priced at a 50% discount to the sector. The market has already rewarded the company with $6 in market value for every $1 in book value—clear indication of the value of its net assets, as outlined previously. A firm can also compound its intrinsic value at the earnings or cash flows it produces off the capital deployed into the business, and how much it invests at these rates. Applying the calculus to PRVA since its listing spits out a value of $3.3Bn in market value, roughly in line where it sells today.

Figure 9.

Critically, my forward assumptions into 2024 put the company at $3.7Bn in market value or $32/share—in line with the technically derived targets above. This adds a layer of confidence to $32 as the initial price objective in my opinion, and also supports the bullish view.

Figure 10.

In short

PRVA's relatively non-complex business model offers upside potential into the coming periods in my view. You've got an asset-light business model that has potential to earn high rates of return on capital deployed, coupled with growth in unit economics and cash flows. A buy rating is supported by the economic value this can create or shareholders going forward in my view. My assumptions have the firm valued at $3.7Bn out to FY'24, and discounting this to today gets me to $32/share—a figure further supported both technically and fundamentally. Net-net, I revise PRVA to a buy, looking for asymmetrical upside with the stock priced at ~1.8x sales, 50% discount to the sector. Revise to buy.

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