iA Capital upgrades Medical Facilities to a Buy

It’s time to get back on board with Medical Facilities Corp (Medical Facilities Stock Quote, Charts, News, Analysts, Financials TSX:DR), according to analyst Chelsea Stellick of iA Capital Markets. Stellick reported on the latest news from Medical Facilities in a Tuesday update to clients where she moved her rating from “Hold” to “Buy,” saying the newly announced change in corporate strategy is a difference maker.

Toronto-headquartered Medical Facilities owns four specialty surgical hospitals in the United States and an ambulatory surgery centre (ASC) in California, along with controlling interest in five other ambulatory surgery centres across the US and non-controlling interest in a specialty surgical hospital in Indiana and an ASC in Missouri.

The company announced changes to its corporate strategy on Tuesday, including a planned sale of non-core assets, the resignation of two Board members and a share buy-back program. MFC said the move comes as the result of shareholder discussions.

“As part of this change in corporate strategy, MFC plans to suspend acquisitions, divest its non-core assets, pursue overhead cost reductions and evaluate and implement strategies to return capital to its shareholders, including the commencement of a substantial issuer bid,” the company said.

On the proposed share buyback, MFC plans to acquire up to 3.45 million shares at C$10.00-C$11.50 per share, cancelling about 11 per cent of shares outstanding. The issuer bid is to be funded with cash on hand and available credit facilities and will expire on October 24, 2022. 

Shares of Medical Facilities were up strongly on Tuesday with the announcement, while overall, returns on the stock have been favourable over the past three years. DR increased in value by 52 per cent in 2020 and by 33 per cent in 2021. With the bump on Tuesday, MFC is now up by about 17 per cent in 2022.

Stellick sees more share price appreciation ahead, raising her target in the new report from C$10.00 to C$12.00, which at the time of publication represented a projected one-year return of 18.9 per cent.

On the proposed cost reductions, Stellick said they’re likely to focus on corporate costs related to expansion and acquisitions.

“In the inflationary environment that has been causing rising operating expenses, we expect overhead cost reductions to offset growing expenses rather than decrease absolute expenses. However, even modest cost cutting may help Medical Facilities overcome inflation which has been a material headwind in recent quarters for DR and its peers,” Stellick wrote.

As to which assets might be sold, Stellick said the company’s four surgical hospitals are core assets but that any of the ASCs could be considered non-core and thus potentially divested. Stellick noted that the five ASCs under the Neuterra name generated $26 million in trailing 12 months revenue and could be worth about $30 million at a 6x-7x trailing EBITDA multiple, while the company’s SCNC ASC generated $11 million in TTM revenue and could be worth about $15 million at 6x-7x trailing EBITDA. (All figures in US dollars except where noted otherwise.)

“If all ASCs are sold, we would expect significant additional share buybacks and some debt repayment,” Stellick said.

Currently with a dividend yield of 2.7 per cent, Stellick said MFC has a low payout ratio at about 30 per cent, which makes a material increase of the dividend likely once the new corporate strategy is put in place. The analyst noted that MFC has about $48 million in cash currently, with $129 million available through existing credit facilities and a debt-to-assets ratio of 0.31, making the NCIB likely easily absorbed.

Stellick has revised her forecast on MFC and is now calling for revenue to go from $411.7 million in 2021 to $422.5 million in 2022 and to $432.3 million in 2023. On adjusted EBITDA the call is for MFC to generate $95.8 million in 2023 compared to $104.1 million in 2021 and moving to $107.0 million in 2023.

On valuation, Stellick has DR’s EV/Adjusted EBITDA going from 4.4x in 2020 to 4.1x in 2021 to 4.4x in 2022 to 4.0x in 2023.

“We have been calling for capital deployment ever since it became clear that pandemic disruptions would no longer require DR to maintain a fortress balance sheet. [Tuesday’s] announcement is a big step in that direction, with a newfound focus on capital efficiency through buying back approximately 11 per cent of outstanding shares and divesting non-core assets,” Stellick wrote. 

“Meanwhile, the headwind of inflationary cost pressures will be mitigated with overhead cost reductions. Therefore, we revise our recommendation to Buy (previously Hold) and increase our target price to C$12.00/share (previously C$10.00/share) based on our EV/EBITDA valuation,” she said.