As a general rule, investing in unprofitable businesses is high risk. With finite cash reserves, a business is living on borrowed time, so long as its costs continue to outstrip its earnings. If a company can?t become self-sufficient, its survival is dependant on the good graces of investors and lenders to sustain it, and even the most supportive of these have limits to their patience.
Even profitable business put investors? capital at serious risk if earnings are dropping, and show little sign of recovering. Sure, there is always the potential for things to turn-around, but as Warren Buffett has said,…
To keep reading, enter your email address or login below.
As a general rule, investing in unprofitable businesses is high risk. With finite cash reserves, a business is living on borrowed time, so long as its costs continue to outstrip its earnings. If a company can’t become self-sufficient, its survival is dependant on the good graces of investors and lenders to sustain it, and even the most supportive of these have limits to their patience.
Even profitable business put investors’ capital at serious risk if earnings are dropping, and show little sign of recovering. Sure, there is always the potential for things to turn-around, but as Warren Buffett has said, “turn-arounds seldom turn”.
At the same time, these types of businesses can offer great reward if investors are able to identify a change of fortune, though great care is needed. One must be extraordinarily careful to ensure that they are not being influenced by an exciting story alone: almost every ailing company purports to be on the cusp of recovery, if not greatness. Sadly, history tells us that most end up being ‘gunna’ companies — those that forever claim they are gunna achieve greatness, but sadly never come close.
A ‘gunna’ company?
Medical Imaging company Promedicus (ASX:PME), although a profitable business, certainly seems to be at risk of being labelled a ‘gunna’ company. The profit it made last year was the second lowest on record, and indeed its net profit has dropped by over 70% over the past decade. Today it claims to be on the threshold of cracking the giant US market, although similar claims were made ten years ago… Is it really sensible to claim that this time it’s different?
Despite poor first impressions, on closer inspection there is actually a lot to like about Promedicus. Though the business’ earnings have been on the wane for the past ten years, the company today is quite different from that of a decade ago. In recent years, Promedicus has undergone substantial structural change, having sold off a legacy business and bought into a new (and most promising) area.
And throughout it all, unlike many ‘gunna’ businesses, the company has remained debt free and has not sought extra money from shareholders. It’s even managed to pay a dividend in most years. Growth may have thus far proven elusive, but it has avoided most of the pitfalls that befall most ‘gunna’ companies.
Why is it different this time?
Promedicus is in the business of providing software for the diagnostic imaging industry – an industry that is undergoing rapid expansion due to the increasing use of imaging technology, and also the substantial growth in the data load of modern medical images.
The recently acquired Visage business is best placed to capitalise on this trend, as it enables clients to manage and view detailed imagery over the internet in a manner that greatly reduces the bandwidth requirements.
Growth expectations here are not ungrounded, with some recent large contract wins in the lucrative US market — which had to progress through a rigorous tender process against some well entrenched and well-heeled competitors. These wins will not only underpin revenue for some time to come, but importantly they effectively promote the efficacy of Promedicus’ systems and act as a meaningful foot-in-the-door to the US market.
As with the broader trend in software, the company’s products are paid for under a subscription model, which produces reliable, annuity-style income for the business. Importantly, the products are rather ‘sticky’, in other words, there are switching costs, both monetary and logistic, which means that when Promedicus wins a new customer, it tends to keep them for a while.
The most recent earnings season revealed a company whose revenues rose by 28%, and with new contract wins making a full 12-month contribution in the current year, this can be expected to further increase. Importantly, with the business enjoying a relatively modest fixed cost base, and also high margins, any new sales should make a meaning contribution to the bottom line.
Promedicus' growth aspirations seem not only well grounded, but the business is well supported by a rock-solid balance sheet and high levels of recurring revenue. Investors can even enjoy a modest, though not-insignificant dividend yield of 2.1%.
More than just a gunna company, Promedicus is a business that has not only demonstrated the credibility of its offering, but one that should see its impressive sales momentum continue as it gains wider recognition and as powerful industry tailwinds continue to provide it with ample opportunity.
Don't miss this! If you love dividend-paying shares, simply click here to claim your free copy of this brand-new investing report, "The Motley Fool's Top Dividend Stock for 2014-2015."
Andrew Page is a Motley Fool analyst. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.