Monash IVF: bless the bumpy road - InvestSMART Monash IVF: bless the bumpy road
Monash's exit from the low-cost end of the market has come at a bad time.
Corporate strategy changes are a bit like having babies – fun to conceive, but hard to deliver. Monash IVF’s recent decision to position itself as a premium IVF provider by converting its low-cost BUMP clinic into a full-service clinic is off to a rocky start.
The company has warned that it experienced weak fresh IVF cycle activity in the first quarter of the 2018 financial year, with the number of cycles down 6.6% compared to the prior corresponding period. The worst part of it is that the overall market rose 4.3%, so the company’s market share fell by 2.5%. Key Points
Volatility nothing new
Loss of doctors a concern
Risky, but low share price compensates
Monash noted that the loss of market share was mainly due to growth in the low-cost IVF market, where Monash no longer participates – and that its transition out of that sector by converting the BUMP clinic had been disruptive.
To make matters worse, this comes just as the company loses its highest-volume consultant and clinical director, Dr Lynn Burmeister, whose contract ended in September. Management said the transition of patients to other clinicians will have a slightly negative impact on financial performance in the first half of 2018. Dr Burmeister’s non-compete agreement ends in late 2018 so, assuming she is up and running at a competing clinic around that time, there may be a larger financial impact in 2019 if she poaches patients.
All up, management expects net profit to be down 20% in the first half of 2018 compared to last year. Management didn’t provide specific financial guidance for the full-year result but said it would provide an update in February. Normal volatility
We’re of two minds when it comes to Monash. On the one hand, it’s business as usual as far as volatile cycle numbers are concerned and the loss of market share. Low-cost competitor Primary Health Care has increased its footprint in Virtus and Monash’s eastern state strongholds, though for the most part it's making IVF accessible to lower income earners, rather than poaching customers from Monash and Virtus's premium clinics. It may seem like a poaching story given the decline in volumes at Monash while the low-cost market expands, but we believe the two markets are, to some extent, operating independently.
Imagine a Louis Vuitton store next to a Kmart. The former's higher prices mean it is further out on the 'cost curve' and so will experience more volatile sales. High prices generally make for sensitive customers.
As the population grows, demand for, say, handbags, may rise along with it, but different markets will experience different levels of volatility. In the long run, it's reasonable to assume more handbags will be sold, but in the short term sales will bounce around. And neither the premium or budget supplier is necessarily a better investment, so long as you pay the right price and calibrate your expectations to the different levels of volatility.
IVF cycle numbers have always been volatile due to the procedure’s high cost and discretionary nature, so our valuation of Monash already accounts for these short-term swings in demand. Nonetheless, Monash’s focus on being a premium service edges it further out on the luxury spectrum, so investors should expect even more boom and bust in cycle numbers than the general market.
Over the long term, however, that general market has strong tailwinds, from which Monash should benefit significantly. Around one in six Australian women of reproductive age are affected by infertility. Of those 750,000, only 37,000 made use of assisted reproductive services in 2015 according to the most recent report by The Fertility Society of Australia – just one in 20.
In countries where the cost of IVF is more generously funded by the government, the number of cycles performed per capita is around 20–50% higher than in Australia, where Medicare funds only half of the total cost.
Even without improved funding, the number of women aged 35–45 is growing at around 1% a year. Prospective mothers are also having children later in life, which is leading to increasing rates of infertility.
The number of IVF cycles performed each year has grown at around 3% annually since the government reduced financial assistance in 2010 and we think 3–4% market growth is a reasonable long-term assumption. The 11% growth Monash achieved last year and 7% decline this past quarter are just speedbumps on a long-term trend.
With a market share of 23%, high returns on capital, a clean balance sheet, strong brand, and economies of scale, Monash has everything it needs to take its fair share of that growth. Still squeamish
What makes us squeamish about Monash – especially compared to larger competitor Virtus Health – is that it has ‘trust issues’. Every time things seem to be back on track, something else shows up. As Warren Buffett has put it, ‘there’s never just one cockroach in the kitchen’.
Three senior doctors and embryologists have resigned in the past two years; a third of Monash’s fertility specialists wrote a letter to the board of directors criticising company culture in 2015; chief executive James Thiedeman resigned in May after eight years in the job; and management has now downgraded its profit forecast twice in six months. Someone get the Mortein.
Thankfully, Cochlear’s previous chief strategy officer, David Morris, joins Monash as chief executive this month, which should shake things up. It may also lead to a few more skeletons falling from closets – but this is a company in need of a shakeup.
All things considered, we aren’t too concerned by the decline in cycle volumes, but it’s hard to disentangle how much of the $3m profit downgrade is due to run-of-the-mill cycle volatility and how much is extra debris being swept under the rug so that Morris has a clean slate to work with.
The stock trades on an undemanding price-earnings ratio of just 11 based on consensus estimates for 2018 earnings. Monash’s highly cash-generative business model, which we explained previously, means that free cash flow has matched net profit almost one-for-one over the past three years, so it's reasonable to assume a forward free cash flow yield in the 7–9% range. Monash pays out most of its earnings and the stock sports a fully-franked dividend yield of 6.9%.
Some companies move forward much as cross-country skiers do – a nice steady speed, with the occasional icy patch. Monash, on the other hand, is akin to a corporate bobsled – still likely to get to the finish line, but be prepared for rapid accelerations and decelerations along the way. We’re lowering our price guide slightly to provide a wider margin of safety, but the share price has fallen further than our valuation. With a recommended maximum portfolio weighting of 3%, we’re upgrading to BUY.
Note: The Intelligent Investor Equity Growth and Equity Income portfolios own shares in Virtus Health. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.
Disclosure: The author owns shares in Virtus Health.
MVF Price at posting:
$1.23 Sentiment: Hold Disclosure: Held
