Medical Facilities Corp DR.TO - Reitmans 2.0?
Unbelievably cheap and in the midst of a turnaround - sound familiar?
Introduction:
This company reminds me a lot of Reitman’s (RET, RET.A), Indigo (IDG) or Alibaba (BABA). Unbelievably inexpensive because they have a lot of baggage. Sometimes things are cheap for a reason, and other times they can be value in plain sight. For most, this one probably goes in the too hard pile. Diligent investors must figure out if DR.TO represents value or a value trap.
I’ve done my preliminary research (inspecting the financials, making a DCF, reading MD&As, transcripts, annual reports, market trends, and smarter investors’ opinions) and currently am on the fence.
Here’s why.
The Bad
As an owner of surgical hospitals, they suffered greatly during the pandemic. Though sales have recovered, the market is very competitive and attracting patients and recruiting and retaining staff is difficult.
The inflation that followed the pandemic has dramatically increased the price of labour (nurses and doctors especially), and medical supplies (drugs, equipment), lowering margins.
They made some bad acquisitions that are still being felt as impairments on the income statement, muddling the financials.
They had to cut their dividend 75%, totally alienating most of their shareholders. They’re going to need new ones.
The Good
Institutions have replaced some of these shareholders. They own enough shares that they’ve got their people in a majority of the seats on the board of directors so can influence the company if need be. They already fired the previous CEO who was being paid almost $2M a year. Meet the new boss, definitely not the old boss.
In Fall 2022 (nine months ago), the company decided to work towards being a quality, shareholder-friendly business by…
suspending acquisitions,
and divesting underperforming non-core assets
to focus on improving margins
and returning capital to shareholders through buybacks and the dividend.
They own four of what appear to be very high-quality and profitable hospitals. Were the company just these assets, it would certainly be worth more. Divestment is a good idea.
The company does surgeries. The United States’ population is ageing and getting sicker, so they have secular tailwinds at their back.
They pay a ~4% dividend, which, in the most recent quarter, was only 37% of their cash flow available for distribution (37% payout ratio).
The company is extremely cheap, it trades at 3-4x EV/EBITDA, while, according to Smoak Capital, acquisitions in the space happen around 7-12x EBITDA.
Pleasingly, they’ve bought back stock aggressively, 16% of the total float last year (including an SIB at a price above $11/share) and continue to repurchase stock through an NCIB this year.
The Future
I trust in the self-interest of the institutions to continue to make the business leaner, and more shareholder friendly. What I’m not convinced by is that these actions will allow the hospitals to remain competitive. You can lower overhead, but if other hospitals aren’t, then it might be hard to recruit and retain patients and staff. This is probably truer for their lower quality hospitals than for their “Crown Jewels,” however.
Competition is an issue especially when we factor in that there are not-for-profits in the sector that have certain advantages (like not getting taxed), which make them hard to compete with. A declining business is a declining business, no matter the valuation (eg Reitmans). That said, this might be a long-term concern, meaning an investment in DR might be better viewed as a 3-5 year trade (like Alibaba) or a private equity turnaround.
Financials, Valuation, and Returns
I spend a bit of time on this because I found it hard to get a clear picture of the financials, which means someone else probably will too.
The four analysts that cover the stock are pretty bullish, believing management will improve margins, though they don’t expect an increase in sales.
EBITDA is on the upswing, back to something more normal. When we consider the buyback program, we can see that this EBITDA improvement is going to be accentuated on a per share basis:
Taking the increasing EBITDA and decreasing share count into account, if we were to value the company based on EV/EBITDA this is what we might come up with:
If you believe these assumptions, this company is looking like a double in 18 months, with very little help from multiple expansion. I guess that’s the beauty of stock buybacks.
I don’t totally believe this though because EBITDA does not tell the whole story here. The earnings/cash generated by the company are shared with a minority interest, meaning less ends up in the hands of shareholders. Management has a useful metric they call “Cash Available For Distribution” (CAFD) which I take as free cash flow. It tells a slightly different story. Here’s what that looks like in the recent past and analyst-estimated future:
On a ratio basis we can compare the EV/EBITDA and P/CAFD ratios to get a fuller story:
The stock is clearly cheap, but not quite as cheap as the EV/EBITDA multiple makes it seem.
To really understand the valuation and what’s being priced in, I took a look at the dividend yield and payout ratio. For a 4% yield, the stock has a very low payout ratio.
If the company were to pay out 100% of its cash flow in 2023 as a dividend, at current prices the stock would yield 15.1%. That’s pretty good. It leaves lots of room to increase the dividend, buy back shares, and pay back debt as needed.
As long as management and the analysts are correct about cash flow per share increasing, it’s clear the stock is very inexpensive, and with a lot of optionality.
Conclusion:
With even minor margin improvements and multiple expansion the stock could double in a short period of time. The same could be said of Reitmans though, and nothing seems to be going right. It is entirely possible nothing goes right.
To invest in this company, I need to be confident in two things:
First, I need to get comfort that management and the institutions that control the board are going to allocate capital in a shareholder friendly way. So far, that’s the case.
Second is the quality of the four main hospitals. They are the cash cows. To what extent do they benefit from demographic tailwinds and how can they cope with competition?
In short, if their four main hospitals aren’t sub-par and management turns out to be accountable and competent, this one’s a winner with multibagger potential.
I’ll keep working on these questions and do an update when I think I might be able to add something. I’d love to actually go visit the hospitals, but they’re quite far for me.
Please let me know if you have any insights.
Thanks for reading!
Disclosures:
I don’t own any stock. Thanks to Smoak Capital, in whose letters I found this one.