Medical Facilities Corp (TSX: DR) was formed on 12 Jan 2004. The Company owns indirect controlling interests in six limited liability entities -Black Hills Surgical Hospital, LLP, Sioux Falls Specialty Hospital, LLP, Dakota Plains Surgical Center, LLP, Oklahoma Spine Hospital, LLC, The Surgery Center of Newport Coast, LLC & Arkansas Surgical Hospital, L.L.C. Each of these entities owns a specialty hospital or an ambulatory surgery center located in the United States.

Investment rationale

• Diversified Business Model: The group’s Portfolio comprised of high-quality surgical facilities in 9 US states. The group has a controlling interest in 4 specialty surgical hospitals located in Arkansas, Oklahoma, and South Dakota, and an ASC located in California. Also, the group has a controlling interest in 5 ASCs located in Michigan, Missouri, Nebraska, Ohio, and Pennsylvania. Further, the group has Non-controlling interest in a specialty surgical hospital in Indiana and Non-controlling interest in an ASC in Missouri. 

• Undervalued compared to the Peers: Medical Facilities stocks trading at a discounted valuation to its competition. From the LTM Price-to-Sales standpoint, its shares were trading at a multiple of 0.29x, whereas peer’s average P/Sales multiple stood at 0.81x, and from the LTM Price-to-Cash Flow multiple standpoint, its shares were trading at a multiple of 1.34x, whereas peer’s average LTM P/Cash Flow multiple stood at 5.69x, which implies a discounted valuation for its shares.

Source: Refinitiv (Thomson Reuters)

• Strong Balance Sheet and Ample Liquidity: At the end of the second quarter, the group had consolidated net working capital of US$74.3 million, compared to US$71.5 million at the end of 2019. Cash and cash equivalents totalled to US$79.8 million, and debt outstanding on a corporate credit facility was US$84.8 million. The US$24.7 million receivable from the sale of the real estate assets underlying UMASH was received in July and used to further reduce the amount outstanding on the corporate credit facility. Overall, the company is entering the second half of the year with a strong balance sheet.

Source: Company Filings

• An Income Play: Medical Facilities is offering competitive dividend to its shareholders, offering a dividend yield of 6.3%, which is substantially higher than the TSX benchmark, TSX Composite index dividend yield of 3.57%. Also, the company has paid a dividend over the past 10-years, regardless of economic cycles.

10-year price chart, with dividend plotted over the chart. Source: Refinitiv (Thomson Reuters)

• Stock is Hovering in a Bullish Zone: Shares of Medical Facilities trading above the crucial short-term as well as long-term support levels of 50-day and 200-day SMAs, which is a bullish indicator. Also, its shares were trading above the immediate support levels of 10-day, 20-day, and 30-day SMAs, which is another bullish indicator. More importantly, these moving averages are also rising, which makes the existing trend stronger.

Moving Averages vs Price Chart. Source: Refinitiv (Thomson Reuters) 

• Risk Associated to Investment: The business of Medical Facilities Corp is exposed to a variety of risks ranging from Foreign Exchange Risk, as the Facilities derive revenue, incur expenses and make distributions to their owners, including the Corporation, in U.S. dollars; Interest rate risk, as the Corporation and the Facilities are exposed to interest rate fluctuations which can impact their borrowing costs. Further, the group is also exposed to Credit risk, as substantial portion of the Corporation’s accounts receivable balance is with governmental payors and health insurance companies which are assessed as having a low risk of default and is consistent with the Facilities’ history with these payors.

2QFY2020: Financial Highlights

Source: Company Filings

• Second quarter total revenue and other income decreased by 5.8% against a year over period.
• Facility service revenue decreased by US$26.6 million or 28.2%. The decrease was primarily attributable to the decline in case volume (US$31.0 million) as a result of the COVID-19 pandemic, stemming from the reduction of elective procedures and in some cases temporary closure of operations or discontinuation of elective cases beginning in the first month of the quarter.
• Overall, surgical case volume for the quarter was down 38%. The largest decrease was in outpatient cases, which decreased 42%. Volume patient cases decreased 25% and observation cases decreased by 20%. Case volumes were most heavily impacted in April, but began recovering the latter part of May, with continued improvement in June.
• EBITDA for the quarter was US$24.6 million or 27.7% of revenue, compared to US$20.5 million or 21.8% revenue in the second quarter of last year. EBITDA increased at most facilities as a government stimulus income and lower operating expenses offset the reduction in volume due to COVID-19.
• In the second quarter, the group generated cash available for distribution totalling CAD8.2 million, resulting in a payout ratio of 26.5%. This compares favourably to the prior year payout ratio of 179%.
• Turning to the balance sheet, at the end of the second quarter company had consolidated net working capital is US$74.3 million, compared to US$71.5 million at yearend 2019. Cash and cash equivalents totalled US$79.8 million, and debt outstanding on a corporate credit facility was US$84.8 million. The US$24.7 million receivable from the sale of the real estate assets underlying UMASH was received in July and used to further reduce the amount outstanding on the corporate credit facility.

Subsidiaries Performance

• ASH’s revenue increased mainly due to the recognition of government stimulus income and case mix driven by a higher portion of surgical volume related to orthopedics cases, partly offset by lower case volume from the impact of the COVID-19 pandemic, which had the most impact in the first half of the quarter.
• OSH’s revenue increased due to the recognition of government stimulus income.
• BHSH’s revenue decreased due to lower case volume as a result of discontinuing elective cases in April 2020 as a result of the COVID-19 pandemic.
• SFSH’s revenue decreased due to lower case volume from discontinuing elective cases in April and the first half of May 2020 as a result of the COVID-19 pandemic.
• SCNC’s revenue decreased mainly due to the slowdown from the COVID-19 pandemic, partly offset by the recognition of government stimulus income.
• The MFC Nueterra ASCs’ revenue decreased mainly due to the volume impact of the COVID-19 pandemic as certain ASCs were mandated to be temporarily closed as part of local state-wide lockdowns.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 11.37% of the total shareholding. CPP Investment Board [Activist] and Dimensional Fund Advisors, L.P. hold the maximum interests in the company at 4.82% and 2.08%, respectively. The institutional ownership in the DR stood at 11.7% and strategic ownership stood at 0.32%, respectively. 

Source: Refinitiv (Thomson Reuters)

Stock Performance

DR shares are featuring a positive price return over the last 5-days, 1-Month and 3-Months and up by 4%, 1% and 11% respectively. Also, outperforming the benchmark index at the same time. However, traded lower on a YoY and YTD basis, down 41% and 8% respectively.

1-year Price Chart (October 06, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

In a year over period, its shares tested a 52W High of CAD 8.28 (on October 24, 2019) and a 52W Low of CAD 2.25 (on  March 12, 2020), and at the last trade price, its shares traded approximately 96% above its 52W low and ~ 46% below its 52W High, reflect a sharp recovery in the stocks since march free fall.

Stock Recommendation: The management is looking for growth by focusing on the capacity expansion of the existing facilities by recruiting new physicians and enhancing facilities and equipment through capital investments. The group is also diversifying the revenue base by adding ancillary services such as urgent care clinics, which is a key positive. The group is leveraging on its nueterra partnership and looking for de novo opportunities and acquisitions.

In the recent quarter, the group reported better than industry average performance in terms of margins amid a challenging operating environment, which is commendable.

Source: Refinitiv (Thomson Reuters), Kalkine Group

However, the group has a relatively higher debt compared to the industry, which put the balance sheet at risk. The group’s long-term debt to total capital stood at 46.8% compared to the industry average of 27.3%.

Further, the group has a decent track record of dividend distribution and continue to distribute the dividend despite the challenging operating environment, which is encouraging from and income investor’s point of view. At the last traded price, the stock was offering lucrative dividend yield.

From the valuation standpoint, DR shares are trading at a discounted valuation. The stock was trading at a forward P/Sales multiple of 0.27x, whereas Peer Average stood at 0.99x. The stock was available at a forward P/Sales multiple of 4.54x against the industry average of 12.75x.

Source: Refinitiv

On the technical front, the stock was trading above the crucial short-term as well as long-term support levels of 50-day and 200-day SMAs, which reflects that the stock is hovering in a bullish zone.

Therefore, based on the aforementioned facts, we have given a “Speculative Buy” recommendation at the closing price of CAD 4.42 on October 06, 2020.

 

*Recommendation is valid at October 7, 2020 price as well.

*Please be aware dividend is variable and not guaranteed.

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