EMIS (LON:EMIS) - a high price for revenue visibility

The market is in an unforgiving mood. Input and wage inflation, stressed supply chains, and staff shortages concerning business leaders and investors alike. But some companies are better able to handle these pressures than others. Namely, companies with business models that characterised by:

• high operating margins,
• high margin stability and scope for operational leverage, and
• high levels of R&D as a proportion of sales.

One such candidate is EMIS (LON:EMIS) , a provider of software to the NHS. Growth has been slow in recent years but its relatively stable mix of strong market positions, technology investment, and multi-year revenue visibility remains highly coveted.

Its operating margin stands at around 21% and the group aspires to increasing profitability. From its most recent annual report:

The Group’s target continues to be increasing operating margins towards 30%, which implies a faster rate of growth in profit than in revenue, to be delivered by operational leverage and greater efficiency in the Group’s systems.

The shares are not cheap at 22.1x forecast earnings and many expensive stocks have derated over the past couple of weeks. But could Emis buck that trend and provide private investors with safe harbour?

---

Profile

What are the company's principal business activities, how does it generate its revenues?

EMIS is listed on the AIM market with a market cap of c£813m, operating in the Healthcare sector. Liquidity is very good, with a 46bps spread and an EMS of 1,500 meaning around £20k can be reliably bought or sold at market prices.

The group supplies clinical software to the UK healthcare market and was originally established to serve the GP market, where it has a leading position with a market share of 57% of UK GP practices. It has broadened its range of products over the years and now serves the community healthcare market, the acute sector, and community pharmacies (where it has c 37% share).

It has main operating segments, each occupying a dominant market positions built up over 35 years providing front line technology to the healthcare sector.

EMIS Health focuses on delivering core software and ancillary services to NHS organisations. It generated 64% of group revenue in FY21.

EMIS Enterprise is mainly private sector and generated 34% of group revenue in FY21. The company is aiming to move towards a 50:50 split.

Business strategy

In order to become ‘the leading provider of innovative technology that improves people’s lives’, EMIS must grow. It plans to do so through innovation, modernisation, and acquisition of technologies.

The potential for sustainable financial growth at high returns on capital is good. EMIS spends millions of pounds every year on research and development, enforcing its already dominant market position and making it a valuable partner to the NHS. In FY21 the group spent ​​£21.3m on R&D - 12.7% of revenue - on things like the EMIS-X platform, which it hopes will drive growth across its two segments, EMIS Health and EMIS Enterprise.

The group’s technology innovation strategy centres on accelerating digitisation of the NHS to support better patient outcomes with a focus on high quality service, products and delivery. That leads to good business retention, and there are ongoing opportunities to expand on the group’s existing portfolio of products into areas such as research and life sciences.

EMIS is also working on ‘elite partnerships’ - growing its partner ecosystem so that it can offer more and enhance customer satisfaction. Additionally, the group has net cash of c£44m, an undrawn £30m bank facility, and a £30m accordion facility to pursue bolt-on M&A opportunities. Recent acquisitions include Pinnacle (2020), Edenbridge (2022), and FourteenFish (2022).

History & Growth

Emis was founded in March 1987 by Dr Peter Sowerby and Dr David Stables in Egton, North Yorkshire. The two GPs identified an opportunity to develop and supply practice management software to GP practices. The first clinical software, named ‘EMIS’, was developed from 1987 with full commercial roll-out taking place in 1990.

In 1999 the company established Egton, the hardware, engineering and technical services arm of EMIS. A management buyout followed in 2008 and the group listed on the AIM market in 2010. Since then, the company has acquired smaller technology businesses such as Rx Systems, Ascribe, Digital Healthcare, Indigo 4, Pinbellcom, and Dovetail Lab. More recently, EMIS has bought PharmOutcomes, Edenbridge Healthcare, and FourteenFish.

Further acquisitions are expected, particularly in the high growth areas of data analytics and integrated healthcare at EMIS Enterprise.

The track record since listing on AIM has been good.

In FY21 the group announced its 11th consecutive year of dividend growth - a refreshing sign of confidence and stability. In fact it has increased its dividend every year since IPO, while growing revenue and adjusted operating profit at compound growth rates (since flotation in 2010) of 10% in revenue and 8% respectively.

---

Management commentary

AGM trading update, 5th May 2022

The Board of EMIS Group is pleased to announce that trading for the year to date is in line with the Board's expectations… the Group continues to have leading positions in specialist markets, benefits from high levels of recurring revenue and remains in a strong financial position, with a robust pipeline of potential new business, investment and acquisition opportunities for 2022 and beyond.

---

Thesis

Few if any companies rival EMIS’s breadth of operations. It is aligned with the NHS Long Term Plan and as far as companies go, EMIS looks secure in its future. That security has value, which comes across in the group’s Balanced RiskRating.

This is a strong business with recurring revenues, good earnings visibility, double digit margins, a culture of innovation and R&D spend, and a net cash balance sheet for further acquisitions. Meanwhile, the group’s EMIS-X platform is proving popular across both divisions.

---

Risks

EMIS suffers from a high degree of customer concentration insofar as much of its business comes from the NHS. From the group’s 2021 annual report:

There is some concentration of risk, as the Group trades extensively with various parties within the National Health Service. However, the Group has long-standing relationships with these parties, which, in addition to the normal credit management processes, assist management in controlling its credit risk.

And again:

The NHS represents a significant proportion of the Group’s revenues; how it is organised and procures goods and services could affect the Group’s ability to sell effectively to this market.

Acquisition risk - EMIS has also acquired several businesses across a range of healthcare sectors. That brings acquisition and integration risk.

Valuation - Finally, the group trades on more than 20x forecast rolling earnings. Deteriorating market sentiment or a rotation out of growth and into value could lead to a falling earnings multiple.

---

Summary

Bull points:

Multi-year revenue visibility, strong profit margins, and sustainable earnings power; net cash for acquisitions; strong market position built up over decades, with a significant % of revenue spent on research and development annually.

Bear risks:

Valuation risk, either from a change in market sentiment or lacklustre growth; single large customer in the form of the NHS; acquisition risk, either from overpaying or failing to integrate properly; competition could create more innovative technologies.