2023-06-28 11:38:32 ET
Summary
- Despite a challenging macro environment, HCAT continues to show strong fundamentals, with growth driven by strategies such as targeting existing customers for up/cross-selling and expanding pipeline opportunities.
- The company is also looking to leverage AI technology to improve efficiency, speed, and cost, which could lead to a higher margin profile and more cash savings for reinvestment.
- I believe that successful execution of the new strategy and macroeconomic recovery could lead to a stock rerating.
Description
In order to help hospitals manage their administrative, financial, clinical, and research data, Health Catalyst ( HCAT ) creates and distributes custom healthcare information management software. I reiterate my buy rating on the stock as the fundamentals continue to be strong and healthy despite a tough macro environment.
Macro weakness
I think the continued weakness in the macro environment since 4Q22 is the primary reason why the stock has not moved significantly higher. Management has observed a decline in pipeline demand and an increase in churn rates due, in part, to the fact that clients continue to experience margin pressure from health system clients. Although management has seen an uptick in client financial performance, they have not seen any changes in consumer behavior as a result. Nonetheless, I take note that HCAT continues to grow despite this headwind, as it keeps adding low double-digit percentages of new DOS clients while maintaining net dollar retention rates of 102-10%.
Growth drivers
There are several growth drivers that I expect HCAT to focus on in order to grow despite the weak macro environment.
The immediate and arguably easiest strategy is to target the existing base of customers to up/cross-sell other solutions. Since the company's prior strategy prioritized net-adds, bears might claim that management has suddenly changed course. This, I would argue, exemplifies management's adaptability in responding to macro conditions. Since these customers are already clients, they understand the value proposition of HCAT solutions, making up- and cross-selling to them an easier task. Particularly, since the communication and repo have already been established, it is simpler to launch a second sales pitch. However, in the current "cost-saving" environment, it is much more difficult to convince new customers to adopt an entirely new solution or replace an existing one. Management has stated that the current 100 DOS clients present the greatest opportunity for pipeline expansion. If HCAT is successful in this strategy, it would also provide the market with a betting understanding on unit economics.
The company could also grow by selling its tech enabled managed service that are geared toward increasing return on investment for existing customers. Management claims that only 10% of DOS customers actually use HCAT's technology-enabled managed services product, and importantly, those who do spend up to four times as much as non-users. As such, the potential for upsell is tremendous here with a lot of potential upside. What happens is that HCAT moves to a binding up to 5-year contract with built-in escalators as customers adopt the technology-enabled managed services offering, giving the business a clear visibility into future growth. NDR enhancements should also gain momentum as the share of revenue coming from such contracts grows.
AI opportunity
In my opinion, AI will be a great asset to the HCAT company as it will allow HCAT to improve efficiency, speed, and cost. HCAT can free up workers to focus on higher-value tasks by using AI to handle routine tasks like data entry. Also, given that HCAT would need to deal with a lot of patients enquiries, AI is a good way to reduce the number of queries handled by human employees as most questions can be easily addressed via generative AI. The net result would be a structurally higher margin profile, providing more cash savings for HCAT to reinvest in the business.
Valuation
In my opinion, the current share price is still not reflective of the intrinsic value of HCAT. I believe the catalyst to the stock rerating will be driven by the success of the new strategy (NDR should trend up from here to convince the market) and the recovery in macroeconomic conditions. My model suggests a target price of $17, representing a 37% increase given the share price has dropped since my last post. As HCAT continues to improve profitability, I believe there is a path for valuation to go back to 5.5x forward revenue (historical average).
Own estimates
Risks
In the long run, HCAT will likely face stiff competition from the large EHR vendors who have already built relationships with hospital and health system CIOs. In order to compete with HCAT, these businesses are willing to invest heavily in interoperability and the development of an integrated data platform. Growth opportunities exist not only for EHR service providers but also for data management-savvy tech companies. In comparison to its competitors, who typically focus on a single application, I believe HCAT retains a significant advantage due to the breadth and depth of its offering.
Summary
Despite the current macro weakness affecting HCAT's stock price, the company's fundamentals remain strong. The management's adaptability in response to the challenging environment is evident, as they focus on targeting existing customers for up/cross-selling and expanding pipeline opportunities. Additionally, leveraging AI technology can enhance efficiency and reduce costs, further benefiting the company's margin profile. Overall, I still think that the current share price does not reflect HCAT's intrinsic value, and success in executing the new strategy and macroeconomic recovery could drive a stock rerating.
For further details see:
Health Catalyst: Share Price Still Not Reflective Of Intrinsic Value