article 3 months old

Integral Diagnostics A Compelling Buy

Small Caps | May 16 2016

This story features INTEGRAL DIAGNOSTICS LIMITED, and other companies. For more info SHARE ANALYSIS: IDX

-Compelling Buy, brokers suggest
-Further purchasing scale to be had
-Indicative of acquisitions available


By Eva Brocklehurst

Brokers are keen on Integral Diagnostics ((IDX)), lauding its decision to purchase Western District Radiology and the other 50% of South West MRI it does not own.

While the enterprise value of the acquisition is not considered large, at $5m, it is strategically sensible, in Credit Suisse's view. The broker observes the stock trades at a material discount to its pure-play peer Capitol Health ((CAJ)), despite having lower gearing and less exposure to bulk billing.

Growth trends in outlays for medical benefits were pared back extensively in the first half and Credit Suisse notes this extends to MRI (magnetic resonance imaging) which, along with CT scans, provides the highest margins for the group.  The states of Queensland, Victoria and Western Australia comprise 45%, 36% and 19% of the company's revenues respectively,

Yet, the broker believes Integral Diagnostics has not sustained the same extent of negative mix-shift experienced by its competitors, given its bias towards high end examinations and the fact that these episodes are referred by sources less likely to be affected by public commentary.

A combination of hospital exposure and incremental MRI additions in regional locations across the second half are expected to support forecasts. Hence, Credit Suisse believes a short-term valuation gap has emerged in the stock and upgrades to Outperform from Neutral.

The broker acknowledges there remains a regulatory overhang, with the Medical Benefits Scheme review ongoing. Nevertheless, with forecasts still including the full impact of the government's MYEFO changes from FY17, amid doubts about whether this initiative will ultimately be actioned, Credit Suisse considers its approach is conservative enough.

The company is considered the best capitalised radiology group, with a desire to selectively consolidate the market, and remains well positioned to execute on further acquisitions. Brokers agrees this latest deal sits well within a hospital environment and bolsters the company's presence in regional Victoria, with an existing contract with the St John of God Hospital in Warrnambool.

Morgan Stanley maintains the company's regional position drives its above-industry average growth, as suggested by the company's first half result. The latest acquisition currently generates annualised revenue of $4.3m and earnings of $1.2m and the broker estimates this to be 1.0% accretive to FY17 earnings forecasts.

The company will use 75% debt funding and 25% scrip, issued to the four radiologists who own the practice and who will remain with the business. Western District Radiology is based in Warrnambool and is likely to gain from cross referrals, given it lies adjacent to the company's Geelong regional footprint.

The stock is a compelling longer term value proposition at current levels, UBS maintains. There is also scale to be obtained with equipment purchases, and this is fundamental to margin gains for Integral Diagnostics.

The broker believes the company has demonstrated discipline on the price and, furthermore, this acquisition has low integration risk. The acquisition is also considered indicative of the accretive, low multiple opportunities that are available. UBS notes this is particularly the case given Integral's existing footprint over three states.

UBS upgrades profit forecasts by 2.8% for FY17 and expects the company to deliver three-year forward earnings growth of 10%, around 15% above its ASX industrial index peers.

On FY17 price/earnings ratios Integral currently trades at a 30% discount to the ASX200 and a 25% discount to listed peers, UBS observes, despite the materially higher growth outlook for diagnostic imaging. The broker also believes the reaction to government reviews is overdone, particularly as cuts to the bulk billing incentive are now likely to be delayed.

FNArena's database has three Buy ratings for Integral Diagnostics, with a consensus target of $1.88 that suggests 28.5% upside to the last share price. Targets range from $1.70 (Credit Suisse) to $2.10 (UBS). The dividend yield on FY16 forecasts is 3.9% and on FY17 it is 6.1%.

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