Some playing with this, page-22

A poor description of Enlitic. Still, it gets the name out there.

From the Marcus Today newsletter (9/6/16).


BUY, SELL OR HOLD

Capitol Health Limited (CAJ) provides facilities and diagnostic imaging services to healthcare industry via 70 clinics throughout Victoria and NSW. Its Diagnostic Imaging Services include General X-Ray, Magnetic Resonance Imaging (MRI), Ultrasound, Mammography, Doppler, Orthopantomogram (OPG), Echocardiography, Computer Tomography (CT), CT Angiography, Cone Beam CT, Nuclear Medicine, Bone Densitomety and Fluoroscopy.

• CAJ’s revenue model is predominantly bulk billing.
• CT and MRI – provides the greatest margin but the highest capital cost (ranging from $300k to $1.5m for CT and $1-1.5m for MRI)
• Ultrasound – is labour intensive and the highest cost service. It has the lowest margins but is the most in-demand modality and the nature of the scans generally leads to other higher margin imaging.

ENLITIC - Enlitic is a San Francisco healthcare IT company founded by Jeremy Howard, an expert in machine learnings. Enlitic will develop algorithms (based on CAJ patient data) that will be entered into the radiography computer, potentially creating a third party to identify and diagnose medical complications. Capitol has agreements with Enlitic that provide Capital with a period of exclusivity in Australia and with international opportunities in the Asia-Pacific region.
CAJ says the partnership between Enlitic and Capitol Health “will develop and implement some of the most sophisticated tools ever used for diagnostic image analysis and the enhancement of medical decision making - delivering significant accuracy gains, efficiencies in medical workflow and ultimately resulting in optimal patient outcomes.”
INVESTMENT CASE
Positives

• Industry drivers are positive – growing and aging population, increasing wealth, increased presence in metropolitan centres, increased emphasis on early detection and prevention, increased acceptance amongst medical community.
• CAJ has dual-track growth strategy - exploring strategic growth opportunities while also seeing organic growth through increased demand for services.
• The NSW and Victoria markets have been highly fragmented – the top 6 market providers account for around half the market share. CAJ currently holds around 5-7% market share so there is scope for significant improvement.
• While there has been considerable consolidation in the domestic radiology industry, CAJ believes there is scope for further consolidation.
• Services can be enhanced through technology – Enlitic, VNA etc.
• There are also opportunities from additional cost efficiencies (while maintaining or improving patient outcomes).
• Business is scalable and adaptive – consolidation and geographical diversity which provides additional opportunities
• Capitol Health says it is is committed to implementing an “Enterprise Imaging Platform” over its network which will enhance the accessibility of scan information, improve distribution of scans to the appropriate specialist and resulting in a more accurate and timely patient result the first time.

Negatives

• Aggressive acquisition strategy, combined with investment in ENLITIC, has resulted in high levels of debt. Gearing is now 80%. This leads to reduced operating flexibility and high interest repayments
• Reliance on government funding – Although Capitol could begin charging a co-patient payment to recover some of the loss of revenue from funding cuts, it is unlikely to be able to fully recover lost revenue.
• CAJ had a profit downgrade last October due to the impact the Medicare review was having on revenue. While the latest update in March was more upbeat, it does highlight the risks.
• In March, CAJ was removed from the S&P/ASX 300 Index.

Regulatory Uncertainty –
In April 2015 the government established the Medical Benefits Schedule (MBS) Review Taskforce. Its purpose is to review more than 5,500 services that are listed on the MBS Schedule across all medical disciplines.
Capitol believes that referrers are more likely to alter referral patterns to avoid government scrutiny at the expense of patient outcomes.
Last December, as part of the first report, the government announced changes to bulk billing rebates for radiology services to commence in July 2016. The plan involved cutting the bulk billing incentive for diagnostic imaging (to concessional patients and those under 16) and scrapping it for pathology services, saving $650m over four years.
Capitol says the details and path for regulatory process remain unclear, particularly since the double dissolution came on the same day that the policy was due to come into effect.
Earlier this week, the diagnostic imaging sector accepted the cut to bulk-billing incentives (with a 6 month delay to 1 January) in return for a review expected to increase the Medicare rebate and a promise the rebate will be unfrozen in future.
The MBS review is due to submit its second report to the Minister for Health in December 2016.
RECENT RESULTS

• CAJ reported slower than anticipated growth in the 1H, due to regulatory uncertainty and the resulting disruption to referral patterns.
• Revenue was in line with previously announced range of 4-6% down on expectations. Ultrasound, CT and MRI were the primary areas of revenue weakness.
• Costs were in line with company and market expectations.

You can view the 1H result presentation here.
OTHER NEWS AND DEVELOPMENTS
CAJ presented at the Bell Potter Emerging Leader Conference in late March. You can view the presentation here.
Trading update:

• There had been a stabilising of referral patterns and of the sector in general. 2H trading (to date) had been in line with previously announced expectations and was showing improvements as initiatives were gaining traction. Management expects a better 2H.
• The broader footprint (post the 2015 acquisitions) was providing earnings diversification and acting as a buffer to geographical earnings irregularities.
• Early indications for 2H16 show volumes are in line and above Medicare statistics.
• It has also suspended the dividend.

MORE RECENT NEWS
In April, CAJ issued $50m in unsecured 4 year notes at 8.25%. The notes were to be used to pay down debt on its banking facility, which was reduced to $75m of which $45. Is drawn.
Capitol has also made two interesting announcements recently. The first was last Friday, when it announced a Memorandum of Understanding (MOU) with Chinese based CITIC Pharmaceutical Company to create a consulting and clinic management joint venture for CITIC’s diagnostic imaging centres in China. Shares rose 5.71% on the day (although they are back to 17.5c currently)
This news was followed on Tuesday with an announcement of an MOU with Sunshine Insurance Group to provide tele-radiology reporting, clinical training and mentoring services at the new 2,000 bed Sunshine Union Hospital (SUH) in Weifang, Shandong Province, China. CAJ said the provision of tele-radiology services to SUH is expected to be ongoing.
Along with the two agreements in China, CAJ noted that the recent Chinese Government healthcare reform has resulted in substantial growth in the private healthcare industry in China. It has seen growth in both private hospitals and public private partnerships such as SUH’s.
The suggestion is that there may be more announcements to come. But while these MOUs could offer a great opportunity for CAJ to expand into China, the lack of detail does make it hard to determine exactly what the financial impact will be.
FUNDAMENTAL VIEW
The fundamentals don’t really support an “investment” in Capitol Health. ROE is 10%, almost half of what it was 2 years ago (although it looks to have stabilised). EPS growth is negative and the dividend has been suspended. The balance sheet is also a big concern with gearing at 80% and a ranking of 1 from StarMine on Credit (a percentile ranking placing CAJ in the worst 1% of Australian companies). The recent note issue has increased balance sheet flexibility a little but there are still concerns.
OUR VIEW – We could easily present a BUY, SELL or HOLD case for Capitol. Take your pick! BUY for strong industry fundamentals with aging population, growing trend to early diagnosis and scope for further consolidation; gains through Capitol’s investment in technology and machine learning; push into China; and more positive trading update highlighting stabilisation of referral patterns, signs of improvement as initiatives gained traction and the expectation of a stronger 2H. SELL because of the high level of gearing and balance sheet constraints and the risks from further changes to the diagnostic imaging industry after the second MBS Review. And HOLD because all the bad news could well be in the price and this could be the perfect recovery opportunity. We're definitely warming to the idea that the emerging Chinese middle class will involve a substantial investment in the healthcare sector and CAJ looks to be already making quiet progress here, and the technological advancements from its ENLITIC investment could be significant. But the regulatory uncertainty and share price volatility are putting us off from being more positive.
We couldn’t put CAJ in the MT portfolios on the basis of the numbers in the STOCK BOX. But those with a higher risk profile could certainly look at it as a trading stock.
TECHNICAL VIEW - This is a three year chart of CAJ on a weekly basis – it’s been a wild ride over the last three years…”all in” or “all out”. The downtrend has clearly bottomed and the stock is in a period of consolidation. A break of the recent high at 22.5c would suggest a higher high and a new uptrend (recovery). If you bought it now you’d set a stop loss at the recent low of 15c and if it then broke 11.5c it would suggest the big downtrend is back in place. Short term MACD (the momentum of the recovery) seems to have peaked and if anything the stock is looking a bit overbought (rather than ‘cheap’) on RSI. Bottom line, it is a recovery trade with a break of 15c being an exit point and a break of 22.5c being an endorsement of the new uptrend.
BROKER VIEW

• Morgans has a Hold recommendation with a target price of 16c (from 37c after the 1H result). The 1H results were in line with expectations but the analysts are still cautious, given the Medical Benefits Schedule review continues to generate uncertainty. They also point out that the interim dividend is suspended pending further capital management considerations.
• Credit Suisse has a Neutral recommendation with a target price of 18c (from 25c after the 1H result). The 1H result was below the analyst’s forecasts. Even allowing for the usual volatility around year end, the trend in the first half has not been encouraging and they believe the company entered 2016 with a number of challenges. The margin for further weakness is considered negligible and they have cut earnings forecasts for FY16-18 by 18-40%, although no adverse impact from the Medical Benefits review has been considered in the numbers.