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This healthcare stock is set for a nice earnings upgrade in 2018

The share price of hospital equipment distributor Paragon Care Ltd. (ASX: PGC) is tumbling lower this morning despite a bullish trading update on acquisitions and a promise of an earnings upgrade in 2018.

Investors aren’t an easy bunch to please – especially for hospital related stocks with the likes of Ramsay Health Care Limited (ASX: RHC) and Primary Health Care Limited (ASX: PRY) underperforming the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) this year.

Paragon Care isn’t immune too, despite its strong track record with the stock barely keeping its head above break-even since the start of the calendar year.

The market wasn’t impressed even as management has made two new acquisitions that are expected to be earnings per share (EPS) accretive. It also reaffirmed its FY18 guidance for revenue to be $125-$135 million and net profit to range between $10.5 million and $11.5 million.

This guidance doesn’t reflect the earnings contribution from the latest acquisitions, so you can expect a profit upgrade to come early in the New Year.

Investors weren’t won over though and there are three possible reasons why the stock is down around 3% to a near five-month low of 79 cents this morning.

The most significant reason is the higher than expected costs in the first six months to end December this year. This includes one-off expenses related to the changeover in the managing director (MD), the setup of its South Australian distribution centre, the restructuring of the capital equipment sales team and the costs relating to the two acquisitions.

The first half revenue guidance of $52-$53 million and net profit of $2.5-$3 million means Paragon has lots of catching up to do to meet its full year targets.

This shouldn’t be an issue as the business is very seasonal. Paragon has historically made the bulk of its sales and profits in the second half of the financial year due to the procurement cycle. This is quite typical for businesses with government clients.

The other reason is the transition of its well-regarded MD, Mark Simari, to Andrew Just. There is nothing to suggest that this won’t be an orderly handover with Mr Simari to stay on to manage acquisitions for the group.

However, the changeover introduces an additional layer of uncertainty and markets do not like uncertainty.

The third reason is the holiday season. Investors shouldn’t read too much into price swings during this period due to the lack of liquidity as most people are away on holiday.

Nonetheless, there is a real risk that Paragon Care can fall further, although I believe the stock is well placed to deliver growth in 2018.

I own a decent number of shares in Paragon Care and I will be looking to top up my holdings if the stock falls to the low 70s.

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Motley Fool contributor Brendon Lau owns shares of Paragon Care Limited. The Motley Fool Australia has recommended Paragon Care Limited and Ramsay Health Care Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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