Summary
- Evolent Health is a high growth stock that has rewarded shareholders with tremendous upside.
- The company has been reinvesting heavily into its growth initiatives at high rates of return.
- Profitability is also a standout based on this point.
- Net-net, we rate it a buy.
Investment Summary
Evolent Health ( EVH ) is a high growth stock that has rewarded shareholders with tremendous upside since our last publication [see: here ]. Following a selloff in November last year we have identified an attractive entry point with shares trading at 2.3x sales and believe there's scope for the stock to continue rating higher. Key points supporting the buy investment thesis include 1) growth rates in post-tax earnings; 2) recent strategic acquisitions; 3) expanding customer networks; 4) incremental return on capital; 5) reasonable multiples.
Data: Author's prior EVH publication
Before jumping into the analysis, I'd recommend investors to observe our previous publication, from where EVH has rallied ~140% to the time of writing. There we completed a deep dive into the momentum it was building around its core operations.
Fundamentals ratcheting up
First, to what's changed since our previous rating on EVH. Top-line sales increased 34% YoY in the last report, with a ~270% YoY surge in core EBITDA. We had modeled CAGR 17% in pre-tax earnings into FY25 and this looks to have eventuated for the company.
EVH revenue growth rate
Data: Seeking Alpha, EVH
In particular, profitability and growth have each been a standout over this period. Using rolling TTM periods to Q3 FY22, we illustrate this in Exhibit 1:
- Note, the company has grown post-tax earnings from a loss of $52mm in Q1 FY20 to $43mm by Q3 last year, leading in with tremendous momentum for its Q4 numbers. On that, it has begun to generate periodic ROIC in the positives, as a reflection of the profitability momentum described earlier.
- In addition, it has begun to ratchet up capital investment, increasing this by ~$799 over the testing period. Key to the debate, is that the company has been heavily reinvesting post-tax earnings heavily into its growth cycle.
- Importantly, this reinvestment into future growth has registered with an incremental ROIIC of 12% over the testing period, corresponding to a 190% company growth rate that's pulled through to a 41% geometric growth in its stock price since the beginning of FY20 [refer to Exhibit 2].
Exhibit 1. EVH growth in post-tax earnings
Data: Author, using data from EVH SEC Filings
Exhibit 2. EVH incremental ROIC since FY20
Note: The data uses rolling TTM periods, as above (Data: As above)
We see the breakdown of this below, with both NOPAT margin, representing the profit per business unit, and the invested capital turnover, that measures capital efficiency. With both measures climbing together, this tells us that both profitability and capital efficiency are improving along with EVH's growth. Looking ahead, this bodes incredibly well in our opinion, as the growth route looks sustainable and can compound without hurting operating margins, thus adding to the buy thesis.
Exhibit 3.
Data: Author, using data from EVH SEC Filings
Adding further detail, it's important to emphasize how EVH has managed to deliver these upsides at the profitability level. Looking below, the company has been redistributing FCF's back into future growth of the business. Equity holders might be upset with the lack of earnings on this, however, we'd note to investors that EVH is reinvesting the otherwise residual post-tax earnings at strong rates of return. This relationship is visualized below [Exhibit 4].
Exhibit 4.
Note: FCF is calculated as FCF to equity holders, as [ NOPAT - Investments]. (Data: Author, using data from EVH SEC Filings)
Additional catalysts driving price change
Two additional catalysts into the new year have added further momentum to EVH's growth engine. First, the company completed the acquisition of NIA, also known as Magellan Specialty Health on a valuation of $650mm or 13x adj. EBITDA. The transaction is disaggregated into cash-scrip deal, comprised of $400mm in cash and $250mm in EVH stock at $29.50/share.
Management expect the transaction to be accretive to operating margins and grow free cash flows, and $85mm to adj. EBITDA over the coming 2-3 years. Noteworthy is that NIA clipped turnover of ~$250mm on adj. EBITDA of $50mm last year. We believe this to be a strategic move to build out the company's value-based care through cost synergies that add to EVH's operating margins, as mentioned. To that point, it is expected to deliver $15mm in immediate cost synergies. This could build to additional synergies in revenue, given the pair's complementary operations in radiology and musculoskeletal medicine.
Second, the company deepened it's customer network by expanding its collaboration with Humana ( HUM ), building on the footprint spanning 36 states. EVH expect the new partnerships in Arizona and Florida are set to generate an additional $250mm in annualized revenue, per the company. EVH made the announcement during its presentation at the 41st Annual JP Morgan Healthcare conference.
Both moves are a step in the right direction and add to the incremental growth profile outlined above. Looking ahead, we opine that EVH will leverage this profitability momentum and continue ratcheting up its growth trajectory.
Valuation and conclusion
The stock is richly priced as a growth name trading at 36x trailing adj. earnings, but is more than fairly priced at 2.9x sales. This is a substantial 30% discount to the sector. Paying ~3x sales means we expect the company to 3x its revenues over the investment horizon period, say, 5-years. We estimate this is a reasonable achievement, given the firm's heavy reinvestment and incremental returns on capital. At 3x sales, we've got EVH's stock price valued at $40, an initial return objective of ~26%. This is well supported by our technical studies shown below, using point and figure charting to derive the price target. P&F charts remove the noise of time and the short-term volatility that blur the directional bias of the trend. Hence, we are seeking an initial objective of $40–$42 in EVH. Moreover, the stock is rated poorly using the Seeking Alpha quant system, however, on the growth and profitability front it has excelled, adding to the reasons of our buy rating.
Exhibit 5.
Data: Updata
Exhibit 6.
Data: Seeking Alpha, EVH
Net-net, we rate EVH a buy on the factors raised in this report, in particular the company's growth rate, its heavy reinvestment at high rates of return, and improving operating margins. We are eyeing an initial objective of $40–$42 from the current market price.
For further details see:
Evolent Health: Strengthening Fundamentals, Investing At High Rates Of Return