The Capitol Health Ltd (ASX: CAJ) share price plunged as low as 12.5 cents today, after announcing a series of writedowns and an expected loss for the 2016 financial year.
Colleague James Mickelboro covered the announcement in more detail here, but I'd like to take a closer look at the company's future outlook.
Valuation
At the current market capitalisation of $72 million, and expecting an underlying net profit of $10 million, Capitol Health is effectively trading on a P/E ratio of 7.2x. That may appear cheap until you consider that the company has $103 million of debt, against $16 million of cash for net debt of $87 million.
That's a net debt to market cap ratio of 121% and represents a significant risk to the company if the imaging market doesn't continue to improve. The build-up of debt has resulted in interest costs of $5.2 million this financial year – although suspending the dividend could see debt being repaid.
The radiology company also says that its core underlying earnings before interest, tax, depreciation and amortisation (EBITDA) will be $23.1 million – only slightly ahead of last year's $22.6 million – despite a 42% increase in revenues. Clearly, Capitol Health's normal expenses have also risen by around 42%.
On an enterprise value to EBITDA ratio basis, the company's shares are trading on a multiple of ~6.9x, which is not exactly bargain-basement cheap.
Danger sign
Capitol Health is also dangerously close to its lending covenants of net debt to EBITDA. It's currently at around 3.8x, and any further falls in EBITDA could see the company forced to raise capital.*
Intangibles
At the end of December 2015, Capitol had $138 million of intangibles – mostly representing the goodwill paid for a series of imaging centre acquisitions. The write-down of intangible assets by just $8.1 million this financial year may not be the last.
The good news
Diagnostic imaging growth is returning according to Medicare data provided by Capitol Health – across all modalities (MRI, CT and Ultrasound). Overall growth in the second half of 2016 was up 3.4%, vs just 1.6% in the first half – as the chart below shows. That should be good news for Integral Diagnostics Ltd (ASX: IDX) as well as Primary Health Care Limited's (ASX: PRY) imaging division.
Capitol also says that its core growth had 'outpaced' the market in aggregate, driven by improved trading in Victorian clinics, and was further supplemented by the continued integration of the New South Wales acquisitions. The chart below shows results with or without including the August 2015 Liverpool acquisition.
Foolish takeaway
It seems clear that Capitol Health remains a high-risk investment and the company is highly dependent on the radiology market continuing to improve. So far the signs of a recovery appear good, but there's still a long way to go.
*Capitol Health refinanced some if its debt with a $50 million unsecured note issue in April – and amended its lending covenants. The two new covenants are as follows:
- Interest coverage ratio (EBIT/interest expense) of greater than or equal to 2.5x. With interest costs of $5.6 million, that means the company needs to have EBIT of more than $14 million. Depreciation and amortisation will need to be below $9 million in 2016 – or the company will breach this ratio.
- The net leverage ratio of secured debt to EBITDA must be less than or equal to 2.5x.
I should also note that those ratios depend heavily on how the company defines certain expenses to get to the EBITDA/EBIT lines.
