Company Overview: Virtus Health Limited (ASX: VRT) is an assisted reproductive services provider, which is engaged in providing healthcare services, which mainly comprises fertility services, medical diagnostic services as well as medical day procedure service. The company has consolidated its operations into 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, the UK, Ireland, Singapore, and Denmark. VRT has ~119 fertility specialists with more than 1,005 professional staff all over the world. Additionally, it has 43 clinics, 56 laboratories, serving more than 37,000 fertility patients annually.

VRT Details

Geographical Expansion & Robust Foothold in AI-Based Techniques are Key Positives: Virtus Health Limited (ASX: VRT) is involved in providing assisted reproductive services, fertility care services and related specialised diagnostic and day hospital services. VRT serves more than 32,000 hospital patients on an annual basis and conducts more than 1 million diagnostics tests annually. The company remains on track to carry on with its key strategies to support future growth across international and domestic ARS markets along with specialised diagnostics and day hospitals in Australia. The company remains well placed to strengthen its footing in the ARS space, given an enhanced focus on providing services across the ARS value chain, low cost, and full-service fertility treatments. Notably, VRT developed its “Ivy” Artificial Intelligence (AI) system, which gained enormous momentum in FY19. In the same year, the company entered into transfer and collaboration agreements for the “Ivy” software with Swedish company, Vitrolife, to focus on further innovation in the field of assisted reproductive services.

In 2019, VRT’s total revenue went up by 6.1%, whereas international revenue soared ~25.2%, aided by a first-year contribution from its new Danish clinic, Trianglen and sustained 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 believes that the ARS market will continue to evolve and VRT remains more focused on service delivery to support patients across a wide range of social and economic demographics, along with meeting the full range of clinical demands vital to the sustainability of the business. In FY20 and beyond, the company’s diversified and vertically integrated platform and its continuous investment in infrastructure will improve its position to capture volume in the ARS markets. 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.

In a recent update, the Australian Federal Government lifted the suspension on elective surgery, containing 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.

Going forward, the company is focussed on growing diagnostic revenue and non-IVF day hospital revenue in Australia. To curb the impacts of COVID-19, the company is taking necessary measures to minimise cash outflow and lessen costs to preserve liquidity. The company has reduced the fixed remuneration for Senior Executives and has decided to defer the payment of the interim dividend. The company’s initiatives to expand International revenue in existing locations deserve a special applaud. Higher investments in scientific research and new technologies including Artificial Intelligence helps the company to deliver improved patient experience.

The company witnessed a compound annual growth rate of 1.8% in revenue in the time span of 1HFY16 – 1HFY20. Also, EBITDA increased 2% over the above stated period. The company remains invested in new technologies and scientific research to enhance profitability through cost reduction initiatives. Growth strengthened as the company is expanding 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 enable organic growth and value realisation in the long run.

Growth in Revenue & EBITDA (Source: Company Reports)

1HFY20 Financial Performance: During the period, revenue went up by 1% and stood at $142 million. EBITDA for the half 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. The company declared an interim dividend of 12 cents per share (fully franked).

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. Notably, the company’s TFCs low price cycles signified 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 increased by 6.6% on pcp. Australian segment EBITDA margin in 1HFY20 came in at 29.9%, almost flat as compared to previous corresponding period.

Key Financial Highlights (Source:  Company Reports)

Balance Sheet & Cash Flow Highlights: As on 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.

Recently, VRT 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 around $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, as compared to $12 million since 31 December 2019.

Cash Highlights (Source:  Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 48.77% 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 10.6%, respectively, representing decent fundamentals.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Risk Analysis: During 1HFY20, the company witnessed a decline in its premium service volumes in New South Wales and TAS due to soft market conditions. Further, the company is exposed to foreign currency risk and interest rate risk. Moreover, lower investment in generating working capital requirement exposes the company to liquidity risk. Also, stiff competition from peers and a high debt burden remains a potential concern.

Outlook: The company expects to grow premium service volume and remains on track to grow its low-price service volume and diagnostics revenue in Australia, going forward. Also, higher non-IVF day hospital revenue in Australia is likely to aid VRT in bolstering its grip in the space. The company is also focusing on increasing its International revenue in existing locations, while pursuing its cost-cutting initiatives.

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-based techniques, 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.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative) 

EV/Sales 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 below 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 has corrected by ~37.90% in the past six months. The company has a Price to Earnings multiple of 7.6x and an annual dividend yield of 8.82%. We have valued the stock using EV/Sales multiple based illustrative relative valuation method, and for the purpose, we have taken Monash IVF Group Ltd (ASX: MVF), Japara Healthcare Ltd (ASX: JHC) and Estia Health Ltd (ASX: EHE) as peers, which come under the healthcare facilities and services space. As a result, we have arrived at a target price of low double-digit upside (in % terms). Hence, considering the aforesaid parameters, long-term outlook, and current trading levels, we recommend a “Buy” rating on the stock at the current market price of $2.69, down 1.103% on 22 July 2020.

VRT Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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