Medica: A High Quality Healthcare Compounder?

13th Feb '20 by Jack Brumby

9 comments 3051 reads

Medica (LON:MGP) is a small cap Healthcare company that ticks a lot of boxes if you’re looking for your next high quality long term hold. Think repeat revenues, strong cash generation, a solid track record of profitable growth, and encouraging underlying market dynamics. There are some concerns, as well - as there are with any other stock - but overall the medium term prospects look good here.

Medica has clearly qualified for other peoples’ screens as well: it made the cut for the 2020 NAPS as a top QM candidate, and it was also in the top 20 picks in our 2020 Stock Picking competition (you can find a list of the top picks in this PDF).

It also qualifies for a screen I recently set up that aims to identify stocks with long term compounding potential. You can read more about the rationale for that screen here but to cut a long story short, it is looking for high margins and returns on capital over multiple years, with a QM Rank of 75 acting as a basic cut off.

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Medica Group was established in January 2004. In 2007, Nuffield Health acquired half of the Group, then John Graham led a management buyout in May 2013. In March 2017, it listed on the London Stock Exchange, raising gross proceeds of £15m, which were used to pay down net debt to approximately £10m.

It has so far generated excellent operating margins and returns on capital. The big question is can it protect them?

What does Medica do?

Medica Group is the market leader by revenue in the provision of Teleradiology services to the NHS. It connects its network of off-site teleradiologists (who review and report on medical scans) to hospitals that then act on those findings. It does this via a bespoke IT platform.

The company currently offers three primary services to hospital radiology departments:

NightHawk - an out of hours emergency reporting service,
Routine cross-sectional (Routine CS) - covering a combination of routine CT and MRI scans (both forms of cross-sectional scan), and
Routine plain film (Routine PF) - covering plain film images.

Of these departments, Nighthawk is the biggest and most profitable division because it provides higher value out of hours emergency scans in less than sixty minutes. The “Routine” divisions assist hospitals in managing their day-to-day…

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john652

13th Feb '20

Hi Jack, excellent article as always. I hold and have for a number of years but i am reticent about this being a bigger position due to the lack of international ambition. I have asked the company about this and they remain focused on the UK. They recruit Australian consultants so surely that is a market to go after, but they have no plans, or at least didn't last year. They also said no plans to use the platform/tech for other services in the nhs. So for me it all seems a bit pedestrian. Im sure if they keep growing there will be a rerating soon but i see no sign of a catalyst to really move the shares.

LeopoldAlcocks

14th Feb '20

Hi John,

I agree that there appears to be opportunities elsewhere. With a 24/365 service, with modern communications there is an argument that they could at least explore other English speaking territories. If successful it would also reduce the key customer risk that Jack highlighted in the article.

However, perhaps it is a case of walking before you can walk. As long as the returns on investing in the UK business can continue, that might be a sensible strategy. Like you, though, I'd like to see an attempt at international expansion at some point

Thanks for the good write upJack,

I'm a holder and you have highlighted the two biggest risks in my view.

The future of the NHS is a bit of a political football, so that key customer risk you have highlighted comes with a side of political risk in my view.

Automation is very hard to predict, and I can't see many industries that aren't at risk from disruption.

Medicine is expensive and extremely important to us all, so I can see more investment going into this industry to try to automate processes and make healthcare more affordable. That wouldn't be a bad thing at all, but I'm keeping my position here quite small

greyster

Thank you Jack, great article. I am a holder in my SIPP as I like the ROCE and margins. I don't mind that there is not yet a huge growth story, as sensible incremental growth on high return business will build value. My position size is small as small cap liquidity makes holding a larger position too high risk, however, I like the business and can sleep at night holding it. You have identified the risks of AI and reliance on NHS, and these are real, but no business is without risk, competitors, substitutes etc and management seem sensible enough to take sensible decisions in meantime.

Greyster

Jack Brumby

Thanks John,

Interesting - I got the international info from page 21 of the 2018 Annual Report... It's still early days, clearly, with no definite commitment in terms of operational goals. Medica (LON:MGP) will update on strategic priorities and FY results on 23 March so we should get more information to gauge how genuine the prospect of international expansion is over the next couple of years.

jjis

Hi Jack thanks for the write up. You asked "If anybody knows of additional reasons for this sudden drop I’d like to hear it."

I think this related to it being a recently listed & at the time relatively highly rated stock which issued a mild profits warning with their trading update on 16/1/18. It got quite savagely treated and hasn't recovered that much since despite as you say delivering decent growth thereafter, albeit perhaps a little lower than people had been expecting.

On other posters concerns about lack of ambition in terms of broadening product offering and not operating internationally. I would just note the appointment of the CEO detailed in the announcement on 9/5/19. He seems to bring plenty of experience in these areas at a previous job he held:

"Stuart will join Medica from Synlab, the international laboratory diagnostic services provider, where he is currently Head of Central and Eastern Europe, Middle East and Africa. Previously he was Synlab's Group Chief Commercial Officer and Chief Executive of its UK operations. Stuart brings a track record of delivering significant growth both in the UK and internationally and has extensive experience of working in partnership with the NHS. During Stuart's tenure in the UK he expanded the business by winning new diagnostic service contracts and through the acquisition of four companies that significantly diversified Synlab's service offering for customers. Prior to joining Synlab, Stuart worked in private equity both as an Investment Director at August Equity and for seven years at 3i in the UK and Germany as an Associate Director focusing on investing in healthcare. Stuart also spent four years at Accenture in the US and UK as a Manager in the health and life sciences strategy consulting practice. Stuart holds a BSc (Hons) in immunology from the University of Edinburgh, a PhD in immunology from Imperial College London and an MBA from INSEAD."

Hope this helps add to the debate. I hold it too as it Scores well in my own screening process which looks for quality stocks / businesses with which to compound a growing income.

Regards

Jamie

Website: Compound Income

Twitter: https://twitter.com/CompoundIn...

15th Feb '20

Thanks for the insight CI,

Look forward to hearing more from the new CEO in the company results.

It's interesting on your site you look for income. I sometimes put a dividend check into my screens but generally leave it out to widen the pool of candidates. There are academic arguments in favour of reinvesting earnings or buying back shares as opposed to paying out divis but I feel that, in reality, a sustainable, growing dividend track record can be quite a powerful quality indicator.

Martin Verlaine

16th Feb '20

I looked at this a few months back but decided that the company seemed to not be looking to diversify. I felt too much dependence on Night Hawk and there did not seem barriers to entry which could easily mean a significant hit on income were rivals to become more significant I.e simply by paying skilled staff more. Had not really followed so note the new CEO and may look again if there is some wider ambition to improve the range of services. To me NH is a cash cow business so the company needs to use this to fund growth elsewhere...

Wol

Thanks for the article, Jack

My concerns for Medica (LON:MGP) would be around the competition that Medica (LON:MGP) will have from AI based analysis. Recent research has shown that AI based analysis of scans can give significantly better results than those provided by human beings. And once set up AI should also be price competitive.

I don't know whether AI will take off in this area or, if it does, how long it will take but there is at least a potentially very strong competitor here.

It is also interesting that the share price has not so far performed well despite the eps growth and the strong fundamentals you discussed above.

Medica: a high quality Healthcare compounder?

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Jack Brumby

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