Normalized Earnings Analysis of CRH MedicalHi all,
So going off of Peter75's post, I wanted to dig into more detail on the normalized earnings power for the current business, present my assumptions, and see what both the longs and the shorts think of my work. I apologize in advance for the length of this post, but given the back and forth between both sides and the substantial reduction in the stock price post-earnings, I wanted to give this topic as thorough an analysis as I could. I hope that all find this helpful.
Also, I am always happy to hear what the shorts think on companies I'm involved in to challenge my own thinking, so if you have critiques on my assumptions, please do share, and I'm happy to discuss and consider your input. After all, my ego should be subordinate to my desire to make money.
From the Q1 2017 call, we know that the current business had the capacity to do 185k cases/year. Let's say that the new FL transaction gave them an additional 10k cases, so the fully consolidated business can do 195k cases/year. This is likely conservative because I believe that the number of cases that are quoted here are not pro forma for a full year of contribution from practices acquired in 2017.
Let's take what I think is a draconian case and say that not only do you get hit by CMS rate cuts, but that management is wrong about the payor mix analysis as the reason for lower average revenue/case in Q2. Let's use $410/case (this and all numbers in USD) compared to LTM Q2 2017 of $464 and Q2 2017 of $417. That gets me to $80M of anesthesia revenue. Assume LTM O'Regan revenue of $11M to get $91M total revenue.
Now, management has reiterated that they think that EBITDA margins after all these cuts will be 47%. I will be more conservative and say 45%. That gets me to consolidated EBITDA of $41M for the business. Management has further argued that roughly 30% of consolidated EBITDA is allocated to the noncontrolling interest. That means that EBITDA attributable to shareholders is ~$28.7M.
Lastly, let's look at the FCF to EBITDA conversion. This business is CapEx light, but let's say $0.1M for CapEx. On interest, there was $59.7M of debt at the end of Q2, then they incurred $5.8M for the new FL acquisition, to get to $65.5M total. On 3.5% interest, that's $2.3M of cash interest. Finally, on cash taxes, I allocate taxes between the noncontrolling interest and us, and think we're probably paying $4M in cash taxes. At steady state, the business would have no additional WC investment, so I leave that at $0. Importantly, unlike Valeant or Nobilis, WC investment has not been that large as a % of sales, so it's unlikely that we have to worry about shenanigans being played with cash outflows in the WC line items.
So in summary
Cases = 195k
Rev/Case = $410
Anesthesia Revenue = $80M
O'Regan Revenue = $11M
Total Revenue = $91M
EBITDA Margin = 45%
Consolidated EBITDA = $41M
EBITDA to Shareholders/Consolidated EBITDA = 70%
EBITDA to Shareholders = $28.7M
CapEx: ($0.1M)
Cash Interest: ($2.3M)
Cash Taxes ($4M)
FCF to Shareholders = $22.3M
So in short, the current normalized earnings power of the business is $22.3M compared to a pre-earnings market cap of $280M (using USD$3.70 and shs outstanding of 75.7M) and a current level of $185M (using USD$2.45).
Even with no growth (which is also a draconian assumption in my mind), this stock appears to be quite undervalued with a current P/FCF multiple of 8.3x FCF. Even with no growth, I would gladly pay 8.3x FCF for this type of business and given the limited amount of leverage.
And again, I reject the focus on EPS. The amortization of intangible assets charge that is the primary difference between FCF to Shareholders and Net Income is a non-cash charge and one that I do not think is an economic charge.
To any short that would like to disagree with me on my view of amortization not being a real expense, I present Warren Buffett's discussion on amortization of intangibles related to acquisitions from his 1983 Letter to Shareholders: https://www.berkshirehathaway.com/letters/1983.html. If you'd like to disagree with me (and him), please present me a valid reason why. Otherwise, Net Income and EPS is absolutely the wrong way to look at this business, and I will continue to disagree with you. FCF is the right way to look at this business, and it tells me that unless there is something wrong with my assumptions, the stock is cheap.
I apologize for the length of this post, but I hope that my views on this are helpful to both longs and shorts. For the shorts, I invite (and gladly welcome) any intellectual critique of my assumptions. None of us likes to lose money, and if you can point out something I'm missing, I'm happy to change my mind.
Best,
PSDFinancier