CRH Medical Corporation Stock Report

CRH Medical Corporation

Revenue and earnings per share had increased rapidly in 2015 and 2016 after the company raised substantial capital in late 2014 and made a transformative acquisition followed since by 30 (and counting) additional smaller acquisitions. The book value per share increased partly due to issuing shares at a price higher than book value. Growth was slower in 2017 with modest growth in adjusted earnings per share and a decline in GAAP earnings per share. (Adjusted) Earnings per share growth resumed in 2018 despite a government-mandated reduction in its pricing. In 2020 adjusted earnings, revenue and more so GAAP earnings were sharply reduced by COVID-19 impacts in Q1 and Q2 but there was only modest impact as of Q3.

CRH Medical Corporation (CRH, Toronto, CRHM, U.S.)
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold shares
Based on financials from: Dec ’19 Y.E. + Q3 ’20
Last updated: January 11, 2021
Share Price At Date of Last Update:  $                               2.23
Currency: $ United States
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Speculative Buy at U.S. $2.23 and Canadian $2.83
Qualifies as a stock that could be bought with confidence to hold for 20 years? No
Has Wonderful Economics? Yes
Has Excellent and Trustworthy Management? Apparently, yes
Likely to grow earnings per share at an attractive rate over the next decade? Yes, unless technology displaces the need for colonoscopies
Positive near-term earnings outlook? Yes but then a decline in 2022
Valuation? Attractive, on an adjusted basis
SUMMARY AND RATING: The graph of revenues and earnings per share shows relatively modest growth since 2016. In part this was due to government-mandated fee reductions in 2018.  The Value ratios based on trailing year adjusted earnings figures would support a rating of Buy or higher. Management quality appears strong operationally. The insider trading signal is neutral to moderately positive. The insider ownership is a positive. Executive compensation is reasonable. The company has had good economics with attractive gross margins and competitive advantages. The near-term outlook is quite good. But they face a probable  big revenue and earning loss in 2022 due to the loss of the contract with a large group of their clinics.  There could be risks that new technologies such as swallowed cameras and/or genetic testing could displace the need for colonoscopies. The company believes this is not a risk but we think it could be. It is a small company. Overall, would rate this as a Speculative Buy at U.S. $2.23 or Canadian $2.83.
LONG TERM VALUE CREATION: With a recent market value of $2.46 for each dollar of original invested equity the value creation has been reasonably good but the share price has been highly volatile.
DESCRIPTION OF BUSINESS: Despite head office being in Vancouver and despite trading primarily in Toronto (it trades in the U.S. also), investors should view this as a U.S. company since all of its revenues and the great majority of its costs occur in the U.S. This is a relatively small company with only about 30 full-time employees plus about 500 contracted Registered Nurses Anesthesiologists (most of whom are independent contractors) and some Physician Anesthesiologists. In 2019, 92% of revenues were derived from its anesthetic services business. The company provides full service anesthetic services for gastrointestinal endoscopic procedures on an exclusive contract basis to ambulatory (walk-in) surgical centers. The company bills private insurance companies or Medicare or Medicaid directly rather than the surgical clinics. Medicare / Medicaid effectively sets its fees but different insurance companies pay differing higher amounts. About 59% of patients pay through commercial private medical insurance and 41% through Federal government Medicare / Medicaid. CRH has transitioned most of the commercial payers to a contracted system that apparently results in a small drop in fees and is something the commercial payers want. The staff providing the services are contracted specialized registered nurses. As of November 2020 the company provided these services at 66 Gastrointestinal-focused ambulatory surgery centers in thirteen states using their large team  of qualified registered nurses under the supervision of several anesthesiologist medical directors. The patient count is about 410,000 annually. The remaining 8% of revenues were derived from the company’s longer standing business of providing gastrointestinal physicians with a patented single-use disposable hemorrhoid banding technology.  The company markets direct to physicians and has trained 3,200 physicians to use its system in 1,200 clinical practices in all 48 lower continental states. They indicated on a conference call there is no other company competing to acquire practices. The competition is just doctors deciding to keep their practice for themselves.
ECONOMICS OF THE BUSINESS: The two lines of business (the smaller hemorrhoid banding product business and the much larger anesthetic services) are profitable and provide recurring revenue. Neither business requires more than very minimal in the way of ongoing capital expenditures. Overall, the economics of the business appear to be strong although the strength has been reduced by the lower fee schedule effective January 2018 as well as by changes in its payor mix.
RISKS: The annual report lists many risks including operational and competitive risks. In our view the more important risks would include potential medical liability and regulatory risks. Also as we have recently seen they are at risk as to the amounts that government and other payers pay for their service. They are not free to set their own price. Technology may also be a risk as it is possible that scanning or swallowed camera technologies could displace the need for colonoscopies. The colo-guard genetic test could also reduce the use of colonoscopies. They face the loss of the contract for their largest customer representing 20% of shareholder EBITDA (and probably a larger share of shareholder earnings). They indicate that contract loss is not a big risk on the remaining customers due to better contract terms.
INSIDER TRADING / INSIDER HOLDING: (Based on data from January 1, 2020 to January 11, 2021).  Three insiders sold some of their holdings  mostly in December at about $3.70 Canadian or $U.S $2.90. One insider bought shares in May at U.S $2.00. Overall considering it is not unusual for insiders to sell and considering the current price, the insider trading signal is neutral to moderately positive. The company itself has been buying back shares regularly.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predictable (marginal pass as the business seems relatively simple but the accounting is complex due to the very large minority ownership and the amortization of the exclusive professional service agreements that represent the bulk of the company’s assets), has favorable long-term economics due to cost advantages or superior brand power (pass due to proprietary products and the steady nature of the business), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (pass), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass)
MOST RECENT EARNINGS AND SALES TREND: The growth in adjusted earnings per share in the past four quarters starting with the most recent (Q3, 2020) was  minus 2% (with some negative impact from COVID), minus 54% (with wide-spread COVID closures in Q2), minus 27% (impacted by Covid-19), minus 2% (impacted by fee reductions paid by non-contracted payers). Revenue per share growth in the most recent four quarters beginning with Q3 2020 was plus 2%, minus 27% (COVID-19 closures), minus 16% (Covid-19), and minus 2%. Overall the recent revenue and earnings growth has returned to about flat after the COVID-19 declines of Q1 and Q2.
COMPARABLE STORE SALES  OR INDUSTRY SPECIFIC STATISTICS: Total adjusted operating expenses per anesthesia case declined to $177 in 2018 from $187 in 2017. And declined further to $171 in 2019. This figure rose in Q1 2020 to $194 due to the volume reduction caused by COVI-19 while operating costs were not reduced until April. The figure fell to $170 in Q3 2020.
Earnings Growth Scenario and Justifiable P/E: The current adjusted P/E of about  6.2 is pricing in either reduced earnings or a high level of risk.
VALUE RATIOS: Analysed at U.S. $2.23 (Canadian $2.83) The price to book value ratio, in isolation is reasonable at 2.2 but note that the company itself paid premiums to acquire the practices such that the tangible book value per share is negative. However, this is a company that is valued for its earnings and the book value is not of much relevance. Based on trailing year earnings adjusted to add back the amortization of intangibles as well as certain other items, the  P/E ratio is very attractive at 6.4 The P/E based on GAAP earnings would be negative due to GAAP losses 75 but we believe the adjusted figure is the far more relevant figure. The adjusted ROE is extremely strong at 34%. The stock is now pricing in an earnings decline or is pricing in relatively high risks. Overall, the value ratios, in isolation, would indicate a rating of Buy or higher based on the adjusted P/E ratio and the ROE. The company indicates that free cash flow to shareholders in 2019 was $29.2 million or 40 cents per share on which basis the shares trade at 5.6 times 2019 free cash flow per share. But free cash flow per share will likely be lower in 2020 due to Covid-19.
Symbol and Exchange: CRHM, U.S. CRH, Toronto
Currency: $ United States
Latest four quarters annual sales $ millions: $106.8
Latest four quarters annual earnings $ millions: $(4.1)
P/E ratio based on latest four quarters earnings: negative
Latest four quarters annual earnings, adjusted, $ millions: $25.0
BASIS OR SOURCE OF ADJUSTED EARNINGS: Due to a change to U.S. GAAP implemented retroactively for 2018 and 2017, our adjusted figures are less reliable as full details were not provided. We added back amortization of the value of purchased contracts (which normally are unlikely to be declining in value although with the 2018 fee reductions they may have) plus any unrealized foreign exchange plus acquisition expenses. Also adjusted for changes in the value of earn-out obligations which are part of finance income / expense. Also adjusted for changes in revenue estimates related to prior periods noted as non-recurring.  Deducted an equity gain in Q4 2019 and CEO severance in Q2 2019. Also added back an early debt repayment fee in 2017. In Q3 and Q4 2018 we added back only the amortization and unrealized FX as other details were not fully available. All these items we tax-effected assuming a 25% income tax rate. Did not add back modest acquisition costs or any unrealized FX in 2020 Q2 or Q3
Quality of Earnings Measurement and Persistence: Overall the confidence with which adjusted earnings are measured is somewhat low. However, the company does reliably generate cash and we expect earnings to grow over time. But there may be a significant decline in 2022 due to probably losing the contract for their largest  group of clinics but with growth resuming thereafter.
P/E ratio based on latest four quarters earnings, adjusted 6.4
Latest fiscal year annual earnings: $3.8
P/E ratio based on latest fiscal year earnings: 42.4
Fiscal earnings adjusted: $28.6
P/E ratio for fiscal earnings adjusted: 5.6
Latest four quarters profit as percent of sales 23.4%
Dividend Yield: 0.0%
Price / Sales Ratio 1.50
Price to (diluted) book value ratio: 2.21
Balance Sheet: (Updated Q3, 2020 The assets consist largely (80%) of the intangible value of the contracts and goodwill that were purchased to acquire its anesthetic services businesses. The remaining assets are mostly trade receivables (10% – possibly indicating slow payments from government and commercial insurers) and cash (2%) and deferred tax assets which result largely from expenses that were not yet tax deductible (6%). The assets are financed as follows: 35% debt, 34% common equity, 24% non-controlling equity, and the remaining 7% is mostly short-term payables. Given the cash flows this appears to be a reasonably strong balance sheet.
Quality of Net Assets (Book Equity Value) Measurement: As the assets consist largely of the intangible value of contracts purchased in acquisitions, the book value is relatively meaningless and this company is valued for its earnings.
Number of Diluted common shares in millions:                                  71.5
Controlling Shareholder: There is no controlling owner.
Market Equity Capitalization (Value) $ millions: $159.5
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 33.7%
Interest-bearing debt as a percentage of common equity 104%
Current assets / current liabilities: 1.8
Liquidity and capital structure: (At Q3 2020) Debt is 104% as large as its share owner equity level (but lower at 60% of total equity including the minority interest) and the company generates adequate cash flows. It has been able to increase its debt to fund expansion. Overall it appears to have reasonable liquidity and balance sheet strength.
Latest four quarters adjusted (if applicable) net income return on average equity: 33.9%
Latest fiscal year adjusted (if applicable) net income return on average equity: 37.1%
Adjusted (if applicable) latest four quarters return on market capitalization: 15.7%
5 years compounded growth in sales/share 47.1%
Volatility of sales growth per share:  strong growth
5 Years compounded growth in earnings/share 11.5%
5 years compounded growth in adjusted earnings per share 92.7%
Volatility of earnings growth:  historically volatile
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted)  earnings per share? Remains to be seen
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 37.1%
More conservative estimate of compounded growth in earnings per share over the forecast period: 5.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 15.0%
OUTLOOK FOR BUSINESS: Q4 should show modest growth. Q1 and Q2 should show strong growth in relation to 2020 which had substantial COVID lock downs and closures. Q3 2021 should show modest growth. Thereafter there could be a material 20% decline or more in earnings per share due to the pending loss of their largest customer.
LONG TERM PREDICTABILITY: It seems reasonable to predict that the company can continue to grow in the long term unless new technologies replace traditional colonoscopies.
Estimated present value per share: In this case the adjustments to earnings are very substantial which reduces reliability which make forecasting earnings growth more difficult. Nevertheless, based on our calculation of adjusted earnings the value would be U.S. $3.32 assuming compounded average growth of just 5% for five years and a higher terminal P/E of 10.
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry exist? (pass based on patents, contracts and expertise). Issues with powerful suppliers? (marginal pass as it is dependent on one critical supplier in its smaller hemorrhoid banding business). No issues with dependence on powerful customers (fail as Medicare Medicaid has dictated its fees and health insurance companies are in a position to somewhat dictate the percentage of the standard fees that they pay and it may be losing a very customer at the end of 2021), No potential for substitute products (marginal pass) No tendency to compete ruinously on price (pass). Overall this industry appeared to be attractive for an established incumbent but the 2018 government-mandated price reductions have put this into some doubt.
COMPETITIVE ADVANTAGE: In its main business of endoscopic anesthetic services its advantage is likely its scale in this fragmented industry. In its smaller and longer-established business of providing a disposable hemorrhoid banding technology it has the advantage of  a patent and established users of its system. The company is working to have instruction on this banding technology included in the curriculum of Gastroenterology programs.
COMPETITIVE POSITION: On the year-end 2018 conference call they indicated that they have about a 10% market share and see a long runway of potential acquisitions. And they said that they were then now accelerating towards the position of the preeminent provider of GI anesthesia which implies that they are not currently the largest provider. On the conference call they indicated that same-store growth rate in patients is 1 to 3%.
RECENT EVENTS: An important negative development is that in December 2020 they received notice that their largest practice contract will not be renewed. This represented 20% of EBITDA attributable to shareholders and probably over 30% of total EBITDA. This is very concerning but they explain that this contract was unique and that all their other contracts had much more protection around renewal. The COVID shutdowns of 2020 were also a big but temporary recent event. The company continues to make small acquisitions with seven in 2019 and a further six in the first nine months of 2020. A new CEO was appointed from outside the company in April 2019. The company has been active repurchasing its own shares for the past several years and continues to do so. This has reduced the share count by almost 5% so far (and that is in spite of some stock options exercised)..
ACCOUNTING AND DISCLOSURE ISSUES: CRH had to switch to U.S. GAPP reporting and has restated 2018 and 2017. This leads to some lack of comparability with previous results. However, our adjusted earnings figures were less affected by the changes. Under U.S. GAAP they reversed a previous write-down of their largest acquisition. This goes to show that GAAP earnings cannot always be taken as the best number to use for any company. The company has a large minority interest (72% as large as share holder book equity as of Q3 2020). This leads to accounting complexity and difficulty understanding the results. The company is required to amortise (expense) the value of its purchased contracts in its anesthesia business. Those contracts are likely to be renewed in the normal course at no additional cost,  and if so are not normally declining in value (though there was some decline due to the government-mandated fee reduction for 2018)  and so we add back that expense net of income tax. But note that they have received notice that their largest contract representing 20% of the business will not be renewed in 2021 but they indicate that this contract was unique and that the other contracts will renew. In the past we have adjusted for numerous items that appeared to be non-recurring. The disclosure of the medical nature of the business is very good. However, the disclosure of the billing process and the payment of those receivables by insurance companies and patients is complicated but is basically absent in the reports
COMMON SHARE STRUCTURE USED: Normal, one vote per share.
MANAGEMENT QUALITY: Management quality appears to be good. A then new CEO was appointed from outside the company in April 2019. The business strategy and execution does appear to be good. They faced a big headwind with government-mandated fee reductions in 2018 but still managed to report a small increase in adjusted operating EBITDA attributable to shareholders.
Capital Allocation Skills: The wisdom of their strategy of growth by acquisition to some extent remains to be seen. All acquisitions prior to 2017 were made without forecasting the full amount of the 2018 government-mandated price reductions and so the return on all those acquisitions will likely turn out to be lower than expected unless offset by other factors such as better organic growth. Also the contract for their first very large anesthesia purchase in late 204 will now apparently not be renewed which calls into question the amount paid to acquire that contract.
EXECUTIVE COMPENSATION: There are just three named executives. Salaries are not at all excessive. The stock award to the new CEO was quite large in 2019 but presumably will not be repeated each year. Incentive pay was provided in 2019 and 2018 but not in 2017. The stock awards appeared to be perhaps overly generous for 2016. But there were no awards for 2017. And some of those 2016 amounts will never be realized until and unless the share price recovers substantially.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. The company has five directors. Two are doctors and all are well qualified. This appears to be a good Board from the perspective of outside share owners.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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