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Summary
Quipt Home Medical (NASDAQ:QIPT) provides in-home monitoring and disease management services, with a focus on end-to-end respiratory solutions for patients in the U.S. It has been successfully pursuing a roll-up strategy, expanding its operations to 26 states and serving nearly 300,000 patients. In recent months, the stock has sold off following a dilutive share issuance in April. The current price presents a reasonable margin of safety, but I give QIPT a Hold rating pending confirmation that management can maintain capital allocation discipline.
Background
Quipt Home Medical provides in-home monitoring and disease management services, with a focus on end-to-end respiratory solutions for patients in the U.S. Roughly 80% of QIPT’s business is providing respiratory equipment through a rental/lease model with associated consumable supplies. The remaining ~20% is related to mobility and related home medical equipment (“HME”). Its payor mix is ~40% private insurance, ~40% Medicare/Medicaid, and ~20% patient pay. ~80% of the Company’s revenue is recurring (e.g., consumables).
QIPT was previously known as Protech Home Medical, and was traded on the TSXV, before changing its name to Quipt and pursuing a dual NASDAQ listing in 2021. In May 2023, QIPT graduated to the TSX and was added to the Russell 2000 and 3000 indexes, which resulted in Blackrock, State Street and Vanguard taking positions initiating large positions (n.b., combined ~6% ownership).
Home care providers are benefitting from several demographic and U.S. healthcare trends. In the U.S., ~10,000 people turn 65 every day, and this population cohort is expected to grow at a ~2.7% CAGR from ’20-’30 (n.b., ~8x faster than the general population), and people diagnosed with chronic conditions is expected to grow at a ~0.9% CAGR over the same period (n.b, ~2.5x higher than the general population). Nearly a third of all Americans suffer from 2 or more chronic conditions, and there are an estimated 24MM Americans with undiagnosed sleep apnea. With the cost of healthcare rising, and an overburdened hospital system, insurance providers are increasingly looking to at-home care to improve patient outcomes, access, and avoid costly hospitalizations.
Additionally, there have been several recent regulatory changes which have been favourable for QIPT. The Centers for Medicare & Medicaid Services (“CMS”) recently announced a CPI adjustment for reimbursement rates on durable medical equipment (“DME”) of 6.4-9.1%, confirming the Company’s ability to pass through inflationary cost pressures and preserve value. This year, the CMS also scrapped the requirement for patients to obtain Certificates of Medical Necessity (“CMNs”) before receiving DME, streamlining the process for healthcare providers to give their patients HME. Another development in 2023 was the ability for patients to be prescribed HME for acute or chronic respiratory conditions.
Given the highly regulated nature of the healthcare and medical equipment market, the industry appears to benefit from high barriers to entry. The upfront cost, effort, and scale required to win contracts with insurance providers and build relationships with HMOs, medical practices, and hospital networks, etc. is quite high. This has translated to a ~20% cash ROA from ’18-’22.
Theoretically, I would assume there are switching costs for customers. Assuming most HME providers charge similar prices, there is a clear and obvious cost to the downtime of not having a CPAP or oxygen therapy unit for any length of time. Furthermore, the majority of patients are covered by insurance and may not be as price sensitive.
Risks & Catalysts
QIPT’s graduation to the TSX and inclusion in the Russell 2000 and 3000 indexes were likely the strongest technical catalysts one could hope for, yet they seemed to do nothing aside from arresting the sell that began in mid-April.
The sell-off appears to have been precipitated by the announcement in April of an issuance of ~5.4MM shares (n.b., ~15% of prior S/O) at C$7.85 per share (n.b., 14% below the month’s average trading price prior to announcement). The shares opened down ~13% the following day, reflecting the value-destructive nature of the issuance, and possibly fears around the Company’s liquidity or leverage position (n.b., proceeds were to be used for “repayment of debt, potential future acquisitions, working capital and general corporate purposes”). In fairness, this was probably a wise move by management, as their cost of debt has likely widened to worrisome levels. QIPT issued an 8% convertible in 2019 when rates were significantly lower (n.b., 3-month BA ~2% vs 5.2% currently). Unfortunately, this issuance also seems to have had the unintended consequence of driving down borrowing rates. Prior to the issuance, the cost to short QIPT hovered in the mid to high teens but has since come down to ~2.5% helping to drive increased short interest. However, the short interest and utilization rate of shortable shares is likely not high enough to present a positive technical catalyst.
To management’s credit, it terminated its ATM equity program in June, in a move to win back the trust of investors and subsequently completed a decent sized acquisition in September.
With no technical catalysts and the underlying business performance solid, the bull thesis must revolve around continued organic growth and future M&A. Organic growth remains strong (n.b., 16% annualized in LQ vs. 8-10% historical target range), and M&A is not entirely off the table as indicated by the September acquisition. However, I do believe the M&A story is now in question with the difficulty the Company will face in sourcing debt or equity at a reasonable cost. Thankfully, an organic revenue growth rate anywhere between the 8-16% QIPT has seen historically would leave enough margin of safety to realize a good return (see below).
The other risks I am concerned about but have not been able to assess adequately are the regulatory environment, bargaining power of payors, and quality of earnings.
As discussed above, there appear to be favourable movements by key regulatory bodies (e.g., CMS), but there is always risk of political action aimed at for-profit healthcare providers. In the same vein, I would need to better understand the relationship between QIPT and payors, and the payors’ incentives towards QIPT. Lastly, I know from prior research into RadNet (RDNT), an operator of outpatient diagnostic imaging clinics, that there can be a lot of noise in the financials of outsourced healthcare solutions providers. I note that the predominantly broker-based valuation below assumes the reported financials accurately represent the Company’s economic earnings. This would be a critical area of diligence were I to seriously consider taking a position in QIPT.
Valuation
For valuation, I constructed 4 cases. All assume a discount rate of 12% and exit multiple of 9x LTM EBITDA (n.b., midpoint of Stifel and LJG). The first case is based on CapIQ consensus estimates and assumes the following:
- Revenue CAGR: 30.6% ‘22A-‘25E / 18.4% ‘23E-‘25E
- EBITDA Margins: 22.7% average ‘23E-‘25E (n.b., 19.6% LQ)
- FCF: 8.3% revenue ‘23E-‘25E average (n.b., 8.3% ‘22A, , management guides to 6-8% revenue)
- Implied Share Price / Return: ~$11.3 / +121%
The second is based on estimates from Leede Jones Gable (“LJG”) and assumes the following:
- Revenue CAGR: 26.3% ‘22A-‘25E / 13.2% ‘23E-‘25E
- EBITDA Margins: 21.6% average ‘23E-‘25E (n.b., 19.6% LQ)
- FCF: 8.3% revenue ‘23E-‘25E average (n.b., 8.3% ‘22A, management guides to 6-8% revenue)
- Implied Share Price / Return: ~$9.4 / +86%
The third is identical to the second, but with the revenue growth rate halved in each forecasted year, and a reduced:
- Revenue CAGR: 13.5% ‘22A-‘25E / 6.7% ‘23E-‘25E
- EBITDA Margins: 21.6% average ‘23E-‘25E (n.b., 19.6% LQ)
- FCF: 7% revenue ‘23E-‘25E average (n.b., 8.3% ‘22A, management guides to 6-8% revenue)
- Implied Share Price / Return: ~$6.4 / +25%
The fourth is a bear case, which assumes the following:
- Revenue CAGR: 10.9% ‘22A-‘25E / 3% ‘23E-‘25E
- EBITDA Margins: 19.6% average ‘23E-‘25E (n.b., 19.6% LQ)
- FCF: 6% revenue ‘23E-‘25E average (n.b., 8.3% ‘22A, management guides to 6-8% revenue)
- Implied Share Price / Return: ~$5.3 / +3%
Conclusion
While there appears to be a sizeable margin of safety in QIPT’s current valuation, I adopting a wait-and-see attitude. Based on my initial impression, it appears to be a decent quality business in a fairly attractive industry. However, I am concerned about management’s approach to capital allocation and the other risks presented above. If I could get comfortable with the regulatory, payor, and quality of earnings risks, and confirm that management had learned its lesson from the April share issuance, I would likely change my mind and feel better about taking a position. I will be watching the newsflow for confirmatory datapoints (e.g., M&A discipline, debt repayment, etc.).