PSQ: Set to smile again?

This article was written by our regular contributor Anton Crabbe. You can read his bio here

It has been amended from original publication  to include a recent update from the business. All changes are in the Outlook section below.

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Pacific Smiles (ASX:PSQ) is the largest branded Dentist Service Organisation in Australia. With 130 dental centres across Australia and plans for more to come. They own and operate 11 NIB Dental Care centres and in July 2020 signed a 10-year Managed Services Agreement with health fund HBF. Under this agreement PSQ operates dental centres in Western Australia, on behalf of HBF, for a fee. Their business model is a mix of a franchise model and a service-provider model offering a range of dental services such as general, cosmetic, and restorative dentistry to various segments of the market, including adults, children, and seniors. 

PSQ doesn't directly employ dentists, rather it collaborates with independent dentists, operating as a support organisation. The model is designed to attract high-quality dentists by offering them modern facilities, administrative support, marketing, and an existing customer base. This allows the dentists to focus on providing dental services while PSQ manages the business aspects of the clinics. 

It comes as no surprise that according to PSQ’s FY22 annual report the bulk of their $139.0m in revenue come from contracts and customers ($138.0m). COVID negatively impacted PSQ’s business as patient deferred dental visits and as a result revenue, earnings and profits all declined, but with COVID behind them, PSQ believes they are in the box seat to grow their business by capitalising on industry tail winds and helping to consolidate the industry.

StockRank:

Given PSQ’s poor performance in FY22 where revenue declined from $153m to $139m, and reported negative operating profit, it’s not surprising to see their current StockRank down at 60. The poor fiscal performance has affected their quality (68), value (36) and momentum (66) too. 

When we look back at their StockRank pre-COVID on the 30th June 2019, it’s a very different story. PSQ were flying high with an overall StockRank of 81 with quality (89), value (54), and momentum (72), all higher on the back of stronger and more consistent financial performance. With FY23 forecast to be a much improved on FY22 it stands to reason that there should be an improvement in their StockRank.

FY19 30th June 

Current 

Financials:

PSQ are in relatively good financial health with an F-Score of 7 and Z2-Score of 1.59. But I am concerned that for a company with a market cap of $217m and $139m turnover, that they have a net gearing ratio of 154%. This is reflected in their F-Score as their long-term debt has not been stable or reducing. The high debt levels can also be seen in PSQ’s liquidity ratios where the quick ratio and interest coverage ratios are low at 0.65 and 0.15 respectively. The fall in revenue, high debt level, and low liquidity ratios have resulted in a fall in operating cash flow and negative free cash flow in FY22.

It is important to note that such a structure can be typical of a capital little (almost franchised like model) business, and given PSQ’s forecast for things to start improving again, I would like to see them focus on paying down debt or maintaining debt levels from here. The company has also resumed paying dividends, though I would they focus the growing cash generation  on paying debt rather than increasing dividend payments in the short term..

FY17-TTM(FY23)

Liquidity and Ownership:

PSQ have used debt rather than equity to fund their business operations. This is not only reflected in the high debt levels and poor ratios, but also that since FY17, average shares on issue have remained relatively flat increasing modestly from 152m to 160m in FY22. 

Of the 160m share on issue, 58% is classified as free float. Of interest though, is that 68% of the company is held by major shareholders leaving only 32% of shares on issue held by smaller shareholders. For most small DIY investors there should be no issue getting in and out of the stock, but there could be significant price movements if some of the major shareholders decide to flex their muscle and buy or sell.

Outlook:

In their last trading update on 12 July, the company reaffirmed FY23 of underlying EBITDA of $24m. Estimates are for revenue to increase to $170m and $197m in FY23 and FY24 respectively.

As you can see above, consensus has PSQ returning to profit in FY23 and FY24 with EPS starting to increase. Brokers are starting to feel more bullish with 2 out of 4 having a buy recommendation with the other 2 holding firm, which is an improvement on 3 months ago.

In an update to market released one hour after the original version of this article was published, the company said that for the FY23, patient fee increase YOY were 19.5%; and
and same centre patient fee were up YOY by 14.7%

The company said the result for the full year is very pleasing, especially the improved performance in the second half. Patient fees and operating costs have both improved half on half, and they are seeing the evidence of scale benefits and operating leverage materialise in a more settled operating environment.

Conclusion:

In short, PSQ are returning to a grow phase after a tough few years. They believe they can capture and benefit from industry tail winds and grow revenue and profits for shareholders. 

A belief that the worst is behind them and profits are just around the corner are one thing, but as always with this type of growth stock you’re paying for some of it upfront and it is up to management to execute the strategy successfully. But for the true believers there does look like there is a bit of upside here with the potential for investors to smile again.

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