Company Overview: Virtus Health Limited (ASX: VRT) is an assisted reproductive services provider, mainly involved in offering healthcare services, which consists of fertility services, medical diagnostic services along with medical day procedure service. The company has consolidated its operations into two segments, namely Australian aggregated healthcare services segment and an International healthcare services segment The company is one of the top leaders in offering Assisted Reproductive Services (ARS) in Australia, UK, Ireland, Singapore, and Denmark. VRT has ~ 119 fertility specialists with more than 1,005 professional staff all over the world. Further, it has 43 clinics, 56 laboratories, serving more than 37,000 fertility patients annually.
 

VRT Details

VRT Rides on AI-Based Techniques & International Expansion: Virtus Health Limited (ASX: VRT) is engaged in providing assisted reproductive services, fertility care services and related specialised diagnostic and day hospital services. Starting with the performance in FY19, the company witnessed an increase of 6.1% in total revenues, which stood at $280.1 million. International revenue went up ~25.2%, supported by a first-year contribution from its new Danish clinic, Trianglen and continued growth in Singapore. During the period, the company remained focused on maximizing returns from operational changes being implemented in Australia, business development in its European clinics and the delivery of greater synergies across its six European sites.  The company opines that the Australian Assisted Reproductive Services (ARS) market continues to evolve and VRT remains more focused on service delivery to support patients across a wide range of social and economic demographics, as well as meeting the full range of clinical demands vital to the sustainability of the business. Virtus’ diversified and vertically integrated platform and its continuous investment in infrastructure confirm its strong position to capture volume in the ARS markets in FY20 and beyond.

The company also implemented key strategic initiatives to support future growth across international and domestic ARS markets as well as specialised diagnostics and day hospitals in Australia. With an enhanced focus on providing services across the ARS value chain, low cost, and full-service fertility treatment through to high-end genetics, the company is well-positioned to dominate the ARS space. Notably, VRT developed its “Ivy” Artificial Intelligence (AI) system, which gained tremendous impetus in FY19. In April 2019, Virtus entered into transfer and collaboration agreements for the “Ivy” software with Swedish company, Vitrolife. The move will aid the company to focus on further innovation in the field of assisted reproductive services. Research continues to remain a key focus for Virtus, and it further aims to enhance its scientific and clinical research activities with an annual R&D investment of ~$2.2 million.
 
Coming to 1HFY20 performance, the company’s revenues and EBITDA went up ~1% and ~21.9% year over year. The company has demonstrated strength in changing market conditions and outpaced overall market growth in Australia. Revenue was positively impacted due to growth in Virtus cycle activity in Australia, which rose ~2.7% during the same time span. Moreover, robust performance by The Fertility Centre (TFC) and progress in Virtus’ Victorian and Queensland cycle activity were key positives during the period.
 
Recently, the Australian Federal Government lifted the suspension on elective surgery, containing Assisted Reproductive Services (ARS), as a result of which, VRT resumed fertility services and ARS treatment in late April with increased infection control and safety protocols. Notably, the company has launched COVID-19 testing for patients after consultation with their fertility specialist, with a 24-hour test turnaround time for results.
 
VRT is investing in new technologies and scientific research to enhance profitability through cost reduction initiatives. Growth strengthened as the company is developing its international revenue, on the heels of organic activities and acquisition synergies in international markets. Additionally, VRT’s diversified and vertically integrated model is likely to facilitate business development opportunities and growth in the long run. The below picture depicts the revenue and EBITDA performance over the period covering 1HFY16 – 1HFY20.
 

Growth in Revenue & EBITDA (Source: Company Reports)
 
Going forward in FY20 and FY21, the company is focussed on growing diagnostic revenue and non-IVF day hospital revenue in Australia. In order to deal with the impacts of COVID-19, VRT has recently taken a range of initiatives to reduce costs and minimise cash outflow to preserve liquidity. The company has reduced the fixed remuneration for Senior Executives and has decided to defer the payment of the interim dividend. It also aims to grow International revenue in existing locations and is focused on cost-cutting initiatives. Higher investments in scientific research and new technologies including Artificial Intelligence helps the company to deliver improved patient experience.
 
Sneak Peek at 1HFY20 Financial Performance: During the period, revenue went up 1% and stood at $142 million. EBITDA for the year came in at $39.5 million, up ~21.9% on pcp. Notably, revenues from international operations grew to 21% of group revenue. EBIT for the period increased from $25.8 million reported in 1HFY19 to $26.9 million. The company’s net profit after tax (NPAT) came in at $15.5 million, up 3.7% on pcp. NPAT was primarily impacted by CEO transition and recruitment costs.  Diluted earnings per share for the period came in at 18.48 cents, up 2.1% year over year. The company declared an interim dividend of 12 cents per share (fully franked).
 

1HFY20 Results (Source: Company Reports)
 
Decent Progress in Australian Operations Fertility: The company’s overall IVF cycle activity in Australia’s Assisted Reproductive Services during 1HFY20 increased 2.7% year over year and came in at 8,302 cycles. Virtus TFCs low price cycles represented 22% of overall Virtus Australian activity, as compared to 17.3% in 1HFY19. Virtus TFCs delivered improved performance across all states. Average number of cycles per fertility specialist in 1HFY20 grew by 6.6% on a year over year basis. Australian segment EBITDA margin in 1HFY20 came in at 29.9%, almost flat year over year. 
 
Balance Sheet & Cash Flow Position: As at 31 December 2019, the company reported a cash balance of $12.6 million. The company’s borrowings at the end of the period came in at $170.9 million.  The gearing ratio was 2.8 times adjusted group EBITDA (LTM). Operating cash inflow in 1HFY20 came in at $23.6 million as compared to $15.1 million in 1HFY19. Free cash inflow after dividends stood at $5.5 million. The company recently provided its liquidity update, wherein it stated that at the end of 30 April 2020, total bank facilities drawn were $173 million in borrowings and $5.2 million in guarantees. Unused and available debt facilities amounted to $84.8 million. The company further stated that ~$92 million of the debt facility will expire in September 2021, while the outstanding $170 million will expire in September 2023. Cash balances at the end of the period stood at ~$25 million, up by $12 million since 31 December 2019.
 
Recent Update: In a recent update on ASX, the company announced that Kathryn Munnings,as VRT’s Group director, has acquired 162,037 performance rights.
 
Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 49.31% of the total shareholding. 


Top Ten Shareholders (Source: Refinitiv, Thomson Reuters)
 
Key Metrics:  In 1HFY20, the company had a gross margin and EBITDA margin of 72.6% and 26.1%, which is substantially higher than the industry median of 57% and 10.7%, respectively, representing decent fundamentals.

 
Key Metrics (Source: Refinitiv, Thomson Reuters) 
 
Key Risks: On the flip side, pricing pressure in the competitive Australian market remains a headwind. During 1HFY20, the company witnessed a decline in its premium service volumes in New South Wales and TAS due to soft market conditions. Further, a debt-laden balance sheet is to be looked at from the risk perspective.
 
Outlook: Artificial intelligence has been a booming accomplishment in healthcare. Outpatient companies choose bots and automated techniques for controlling and managing health information. With the support of AI, hospitals will accomplish better outcomes, while patients will receive more effective and differentiated care.  Virtus commercialises “Ivy” AI technology. Notably, Australian fertility experts are now testing the technique, which practices artificial intelligence to advance the odds of a positive pregnancy. This poses promising outcomes for the company’s IVF success in the future. It is also expanding its R&D activities into new spheres in the health care industry wherein AI can additionally improve and enhance patients’ outcomes on a global basis.
 
Furthermore, for FY20 and beyond, VRT expects to grow premium service volume and remains on track to grow its low-price service volume and diagnostics revenue in Australia. Moreover, higher non-IVF day hospital revenue in Australia will eventually aid the company in strengthening its foothold in the space. It also aims to grow International revenue in existing locations, while pursuing its cost-cutting initiatives. 
 
 
Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)
 
Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)  

P/E multiple based relative valuation (Source: Refinitiv, Thomson Reuters)
 
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
 
Stock Recommendation: The stock of the company is currently trading close to the average of its 52-week trading range of $1.505 - $5.280. In 1HFY20, the company delivered a decent result, driven by the Virtus cycle activity in Australia. As per ASX, the stock of VRT corrected ~32.01% in the past six months but went up ~42.59% in the last three months period. The company has a price to earnings multiple of 8.6x, and an annual dividend yield of 7.79%. We have valued the stock using P/E multiple based illustrative relative valuation method, and for the purpose, we have taken the peer group - Monash IVF Group Ltd (ASX: MVF), Japara Healthcare Ltd (ASX: JHC) and Estia Health Ltd (ASX: EHE). As a result, we have arrived at a target price depicting an upside of lower double-digit (in % terms). Hence, we recommend a “Buy” rating on the stock at the current market price of $3.12, up 1.299% on 24 June 2020.
 
 
VRT Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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