The Pro Medicus Limited (ASX: PME) share price has rocketed over the past 5 years from 95 cents to $28 today, yet it receives far less media, analyst, or investor attention than vertiginous share price growth rival Afterpay Touch Group Ltd (ASX: APT).
This is probably because Afterpay is an increasingly ubiquitous consumer-facing business, whereas Pro Medicus operates in the enterprise-facing, cloud based, software-as-a-service space (SaaS) that is extremely hot with powerful institutional investors right now.
On May 30, 2019, the research arm of Goldman Sachs initiated coverage of Pro Medicus with some interesting insights into the business and other players in the healthcare sector.
Pro Medicus provides medical imaging software to healthcare providers mainly under its Visage 7 technology platform and Goldman’s notes the impressive progress it has made.
“The company has secured long-term contracts with 5 of the Top 20 hospitals in the US, including the prestigious Mayo Clinic and Partners’ Healthcare network, which we view as a strong vindication of this technology. We see clear scope for deeper penetration of this group and, as the track record grows, we expect slow but steady penetration of the mass-market channel,” the analysts state.
There’s a couple of points to note here in my view.
First, it seems Pro Medicus boasts market-leading software in a lucrative space which is unusual for a small-cap or now mid-cap tech business. This may provide it some pricing power and competitive advantages over the long term. Legendary investors such as Charlie Munger often cite pricing power or market-leading products as key qualities to look for in companies.
Another business in the SaaS space that is generally regarded as having built a moat or competitive advantage as a market leader in its space is Wisetech Global Ltd (ASX: WTC). Its shares have gone ballistic as well, but much of Wisetech’s recent growth has come about via acquisitions.
Notably, Pro Medicus is generating strong organic growth, which in my view makes it a potentially better prospect than Wisetech.
As a result of its growth prospects Goldman’s is forecasting a 23% compound annual EBITDA growth rate for Pro Medicus between FY 2019 to FY 2022.
That means it’s Goldman’s top ASX healthcare pick in terms of upcoming EBITDA growth, ahead of Japara Healthcare Ltd (ASX: JHC), Healthscope Ltd (ASX: HSO), Cochlear Ltd (ASX: COH) and Fisher & Paykel Healthcare Ltd (ASX: FPH). Goldman’s forecasts these rivals to deliver compound EBITDA growth between FY 2019 to FY 2022 of between 10% to 15%, which is still pretty impressive on a compound basis if achieved.
But isn’t the valuation a little high?
At a record high of $28 today Pro Medicus is now valued at $2.94 billion which on a basis of trailing financials looks ridiculous.
However, it’s the future that counts in the share market and Goldman’s is forecasting Pro Medicus will deliver a profit of $25.7 million on revenue of $64.2 million in FY20, which translates into 25 cents in earnings per share and a superb return on equity of 40.4%.
We can see then how Pro Medicus is a profitable asset that operates on high gross profit margins that are the calling card of cloud-based SaaS businesses.
Still on Goldman’s forecasts shares at $28 change hands on 112x FY20’s forecast EPS and 93x FY21’s forecast EPS of 30 cents. Goldman’s has a $24 12-month share price target on the business.
As the analysts acknowledge one unknown factor that could swing the valuation is Pro Medicus delivering large new client wins on a sales pipeline that it consistently reports is very strong. Notably, management has a track record of delivering on its optimism.
Still the shares currently look expensive on almost every measure, with downside risk it it does not deliver upside surprises to Goldman’s analysis. As such I’d rate them as a hold for now.