2023-04-19 13:05:29 ET
Summary
- RadNet, Inc. has projected itself to have a strong FY'23 from a period of heavy investment last year.
- The firm has added numerous de novos and expects to bring more online this year.
- Same-store sales and average turnover/costs per store have moved favorably, a trend which might continue.
- Net-net, I reiterate a buy rating on RadNet, Inc.
Investment Summary
The performance of RadNet, Inc. ( RDNT ) since my December publication on the name has vindicated my medium-term investment thesis. For patient investors, RDNT has been a fantastic buy since I rhapsodized the case back in August last year, up some 40%, knocking the $26.50 price target out with vigor. Some remarks from that report:
RDNT presents with the desirable equity premia that investors are paying a premium for...it is well positioned to benefit from industry tailwinds in the rebound from Covid-19...its offering within medical imaging, is well differentiated within the healthcare space.
Imaging ties into a multitude of medical and allied-health domains that extract countless sources of income. It is also a necessity of specialist medical treatment in almost all cases, and remains just about as defensive as it gets."
These same characteristics are present today, despite the psychotic volatility in global securities markets, driven by uncertain central banks and declining business activity.
In my view, the macroeconomic gods have presented us with RDNT on a plate at 31x forward earnings (derived from my own numbers), given the firm's defensible positioning along the healthcare spectra, impervious to a global GDP meltdown.
RDNT could deliver 9–10% YoY growth in revenues this year to $1.56Bn on operating profit of $102mm on my estimates. At a time when the "earnings recession" is looming, I believe RDNT's investors could see 50% EPS growth and ROE of 9% by year's end. Hence, I am nibbling at the current market cap of $1.6Bn, still seeking the 2nd price objective of $32.50 I outlined previously.
I'm not revising this target higher for the time being, however, RDNT could still be fairly valued up to $36 in my estimation, as shown here today. Capital requirements are intensifying for the firm as it grows, and I'd like further evidence it can grow earnings without jeopardizing growth, and vice-versa, beyond FY'23 before rating it any higher. For the time being, RDNT still presents with attractive growth characteristics that could see it-rate positively over the coming 12 months.
Net-net, I am retaining a buy rating but will be intensely scrutinizing the firm's 1st quarter numbers as they come in the following weeks.
Fig. 1 – RDNT coming out of long, flat base and heading back to range
Current operations accretive to value
If we talk in first principles, and we must, RadNet, Inc. provides medical imaging services to physicians and hospitals. It, therefore, lies at a critical juncture in the medical, surgical and healthcare continuum. This is a mutually-beneficial partnership between referrers seeking answers, and RDNT, the medium to provide them. Consider that:
- Physicians, surgeons, specialists, etc., require this service to accurately make diagnoses of diseases, conditions, and disorders.
- It is an absolute necessity. Without it, there would be no informed decision making by these clinicians.
- The same goes for pre and post-surgery.
- This ranges from basic scans (X-ray) to more complex, detailed imaging such as MRI.
- Referrers include physicians, hospitals, specialist surgeons, allied health care, insurance, among others.
- This is a hub-and-spoke type model whereby RDNT sits in the middle of a circle of linked referrers.
In terms of defensibility, this is the type of industry you want to be in with macro-volatility. Especially given the suite of imaging that falls under Medicare and private health insurance.
Key economic measures ratcheting up
RDNT certainly isn't the only imaging provider "in the area." Although, it has a key point of differentiation – multi-modality imaging . This is where more than one imaging technique is utilized at once. Two or more scans can be completed at the same time, to provide a more comprehensive outlook and obtain the maximum amount of data in one go. So, in addition to the symbiotic benefits listed above, multi-modality imaging is a key insulator for RNDT:
- It diversifies the top-line away from reimbursement streams, hedging against reimbursement risks.
- Referrers have a single contact point for multiple procedures, adding a multiplier of new of revenue streams.
- Competitive tensions are, therefore, more benign given RDNT can consolidate multiple imaging techniques into a single price point.
It is really quite a simple formula when extrapolating the value proposition for RDNT. Revenue is a function of turnover per store, with OpEx/store and CapEx/store governing the cost and profit structure. Revenue is booked through utilization of RDNT's various "equipment," plus ancillary products/services. Therefore, growth is a function of: 1) growing revenue per store; 2) investing into new stores; 3) leveraging size for better costings; and 4) increasing same-store sales. Rinse and repeat.
Store economics are quite simple too – each facility has a certain number, and type of equipment, ranging from MRI, CT, PET/CT, Mammography, etc. (see: Figure 3]. Each unit of equipment performs scans that differ in time. Often scan types are grouped based on the referral. Each unit can do a potential range of patients per day, based on the mix of patient and scan type/length. Revenue is booked after the scan is performed, including any ancillary services. Operating costs are largely labor related, combined with running costs of the equipment. Capital charges are maintenance and investing into more, or upgraded machines/equipment, to generate higher profits over time. There are regulatory costs as one-line items.
Hence, store economics are a function of number of machines times revenue, cost, profit, per machine. I'd look at this as an hourly average if getting to the nuts and bolts of it. Currently, there's 6.8 machines per location, with an average 1 MRI machine at each [Figure 2]. These are both flat on FY'21. Hence, it tells us that with increased avg. turnover per store on flat average equipment per store, this was higher income per machine last year.
Fig. 2
Data: Author, RDNT 10-K's
Fig. 2a
Data: Author, RDNT 10-K's
Looking to the numbers in greater detail [observe with Figure 3, Figure 4 below]:
- RDNT grew total stores under management to 357 in FY'22 from 331 in FY'20. Management talk of bringing another 12 or so de novos online this year, which could be 369 with no disposals.
- Average revenue per store is flat from FY'20 at $4mm, but up marginally from FY'21.
- Total average Opex per store has increased from $0.29mm to $0.67mm last year. My numbers project this to be flat in FY'23.
- Importantly, average CapEx per store has been trending down the last 2– years, and I believe this could continue looking ahead.
- Equally as important, same-store revenues have lifted to $1.4Bn from $1.2Bn the prior year.
- This, on same-store revenue growth of 10% YoY.
My numbers project another 9% same-store growth at the high end for FY'23. This is above management's forecast of 3–5% same-store growth. Hence, if this is correct, it could be result in a continuation of RDNT's current 6-month rally.
Fig. 3
Fig. 4 – RDNT
Data: Author, RDNT 10-K's
Growth also increasing capital intensity
Service-based industries have tremendous capacity to increase profitability without a large capital spend. However, RDNT's CapEx requirements have shifted higher in the last few years. The firm is pushing for an excellent 2023 judging from language on the FY'22 earnings call . Hence, it expects a solid top-line performance to $1.575 at the upper end of guidance, with $115mm in capital investment. I believe this is fair and see RDNT clipping 9-10% revenue growth to $1.56Bn, well within range.
However, to get there will be quite expensive in my opinion. I've got CapEx hitting more like $155mm this year, with another $35mm in working capital requirements, for a $190mm total capital charge. It is adding a dozen or so more de novos after all, notwithstanding the number it bolted on last year. I also project the firm to reinvest ~$17.5% of post-tax earnings to fuel future growth investments. All up this calls for a $206mm investment to continue expanding and generating more profits in FY'24. This would lead to a $114mm free cash outflow, no residual earnings, and come at a cost to shareholders in the short-term. Note, this is exclusive of any cash acquisitions the firm intends to make. It is noteworthy that, the firm also spent a collective $238mm in cash acquisition over the last 3 years.
Where is it investing, includes:
- Strategic acquisitions (potentially).
- Artificial Intelligence ("AI")
- Teleradiology capacity
- Building out its own IT platform.
The other hurdle that needs clearing is the capital intensity tied to this growth. You'll see below that capital intensity, measured by sales over invested capital, has been drifting lower. It has fallen from 1.2x in FY'18 and hit 0.8x last year. A higher number is better, signaling higher productivity per unit of capital. Looking to my numbers, I think it will remain at ~0.8x going forward.
Fig. 5
Data: Author, RDNT 10-K's
Whilst this isn't an unexpected symptom of growth, how RDNT handles the issue with profitability will determine the value to shareholders. In FY'23 my estimates have RDNT to print $93mm in NOPAT, a growth of $49mm YoY. On a $206mm investment, this would generate a 25.4% return on the incremental capital. With the higher book value and $50mm in projected earnings, it could deliver a 9% ROE. Hence, for FY'23, my insatiable thirst to position against firm's generating incrementally higher returns on capital and equity is satisfied in this instance.
Valuation and conclusion
The market has put an enormous mark on RadNet, Inc.'s forward earnings multiples. It trades at 123x FY'23 GAAP EPS estimates. On my numbers, the market has it valued at 31x forward earnings [see: Appendix 1]. But I think we need to be more pragmatic in valuing the company. Net margins are tremendously thin for this name at ~3%, even with a 10% average ROE these past 5-years. Hence, I'd be looking at the operating line as a cleaner measure of the cash RDNT can throw off.
I believe RadNet, Inc. can generate $102mm in EBIT this year. Consensus has it valued at 35x forward EBIT, but the Street is heavily under-forecasting RDNT's pre-tax income this year in my opinion. The sector meanwhile trades at 21x and this is very reasonable for RDNT in my informed opinion. At 21x my FY'23 estimates, this throws a valuation of $36, within 1 standard deviation to the previous $32.50 price target.
In short, RadNet, Inc. looks primed to deliver a strong year of earnings growth and growth in operations. I believe investors will continue rewarding the stock even at such lofty multiples. Net-net, I haven't made any changes to the $32.50 price target outlined previously, but I'd be looking for RDNT to potentially scoot past this to ~$36 if it were valued fairly.
Appendix 1. RDNT 5-year P&L forecasts
For further details see:
RadNet: In For A Big FY 2023, Look For De Novo Contributions