IVF cycles are the bread and butter of Virtus Health (ASX:VRT), and when it was floated in 2013 it was off the back of a couple of years of 6% growth.
Investors bought into the excitement –as, unfortunately, did we – before weaker growth in recent years, combined with increased competition from lower-priced offerings, have seen the share price almost halve.
Three weeks ago, we acknowledged the recent weak growth in cycle numbers by cutting our estimate of long-term growth in IVF cycles in Australia from 3%-4% to 2% and bringing our buy price down to $4.50.
We are, however, still expecting growth. As we’ve explained previously, increasing rates of infertility make it hard for us to imagine a world where there is not substantially more demand for IVF 10 years from now than there is today.
Yet Virtus’s share price, which now reflects a price-earnings ratio of only 11 and a free cash flow yield of almost 10%, seems to allow for no growth at all.
We think that pessimism is offering up an opportunity to buy the largest player in a domestic market with reliable – albeit muted and volatile – long-term growth prospects.
It may even be able to add to this if it can translate its local success into an increasing presence in international markets.
The underlying volatility of the IVF market makes for a bumpy ride, which is why we give Virtus a share price risk rating of high and a business risk rating of medium-high.
The company also lacks the quality we initially thought we’d identified, so we’re (somewhat belatedly) nudging down our recommended maximum portfolio weighting from 5% to 4%.
However, at current prices we’re being given a wide margin of safety and we’re upgrading to BUY.