Like a lot of people I’ve had my fair share of scans over the years. In my case usually knees. They’re expensive, but as you are usually in pain, you don’t argue with the doctor’s recommendation. Fortunately, Medicare usually picks up some of the bill.
Often you are sent to a private practice in the suburbs or sometimes the scans are conducted within a hospital. Most of these practices are privately owned, including the ones within public and private hospitals.
There are a number of companies that own these networks of diagnostic imaging practices. The largest is I-MED Radiology, which is privately held, with more than 200 practices. A listed alternative is Integral Diagnostics (ASX: IDX) with 53 practices.
The practices are mainly around the Gold Coast, Victoria and Western Australia. In July this year, Integral Diagnostics expanded into New Zealand with the acquisition of four practices along with two more in Geelong, Victoria.
Integral Diagnostics provides diagnostic imaging services to general practitioners, medical specialists and allied health professionals and their patients.
With growing and ageing populations in Australia and New Zealand, and community expectation for higher quality healthcare and diagnosis, the outlook for diagnostic imaging businesses is positive. Improving imaging technology aids diagnosis and helps with early detection of diseases leading to better preventative care.
Diagnostic imaging is a business that benefits from scale as the equipment is expensive and qualified staff are sought after.
It is likely that IDX will continue to build scale by gradually acquiring practices. It is also possible that they could be an acquisition target.
Indeed, earlier this year rival Capitol Health Ltd (ASX: CAJ) launched a $312million scrip bid for IDX. The IDX board rejected the offer and since then the stock price has risen about 30%.
A significant risk for IDX is its dependence on government schemes for a high portion of its revenue. Decisions by Medicare have a direct impact on revenue. For example, in July 2018, the Medicare benefits schedule (MBS) rebate on an MRI of the prostate was introduced.
About 18,000 men in Australia are expected to be diagnosed with prostate cancer in 2018 and about 3500 will die from the disease.
Men who have had a blood test and have raised antigens in their blood for prostate cancer are now eligible for a Medicare-funded MRI scan.
MRI scans are approximately twice as accurate as other diagnosis tools and avoid undergoing invasive and riskier biopsies. The scans cost about $600 about $400 of which can be claimed as a rebate. This will have a positive impact on IDX as more men avail themselves of prostate scans.
On the flip side, MRI scans of knees for people over 50 that are requested by a GP are no longer eligible for a Medicare rebate as of November 2018.
So how do the financials stack up? Revenue grew by 5% in 2018 but is forecast to grow by 28% in 2019. This growth is largely on the back of acquisitions. It achieved a strong operating margin of 20% and return on equity is also about 20%.
These are very healthy numbers. If the acquisitions deliver similar levels of operating return then forecast growth in earnings per share of almost 50% may be achievable.
The balance sheet is not quite as attractive. Over half the total assets consist of goodwill from prior acquisitions.
The most recent acquisitions were debt funded, which would have pushed the net debt to equity ratio to over 100%. Debt funding at the stated average rate of 3.8% increases profitability but it also increases the risk profile in the event that things don’t turn out as planned.
The valuation metrics are about fair value at a forecast PE ratio of about 15 and dividend yield of 4%.
Given the current state of volatility in markets and the risks on the balance sheet side it does not look like a bargain at the moment. Organic growth is contained by population and regulatory factors so growth needs to come through expansion.
IDX looks like a well-run business in an attractive segment but it is not a low-risk proposition given the risks outlined. If there is a price retraction the risk return trade-off may justify an investment.