Integral Diagnostics (IDX)

Simon Turner
Senior Equity Analyst
8 am 24 September 2020
Prior close: $4.06

Sector tailwinds create defensive growth profile

Integral Diagnostics (ASX:IDX) provides diagnostic imaging services to the Australian and New Zealand medical sectors. With 74 radiology clinics, the company is the fourth largest player in the Australian market after I-Med, Sonic Healthcare and Healius. As shown below, IDX is particularly exposed to the Victorian, Queensland and New Zealand markets. The company has 28 MRI machines, of which 13 are fully licenced (unlicenced machines incur out of pocket expenses for patients).
Source: IDX 2020 results presentation
IDX is benefiting from a trend towards the greater use of high-end scans such as MRIs and high speed cardiac scans in preventative medicine. The information provided by diagnostic imaging is hard to replicate by other methods, so solid long term sector growth looks certain, particularly in Australia where MRI use is well below that of the US and Canada. In addition, the return on MRI investment is particularly attractive as it often avoids the need for surgery or additional visits to a specialist.

What’s ahead for IDX in 2021, after some COVID-related challenges in 2020?

2020 full year result

For the year ended 30 June 2020 IDX’s operating revenues grew 19% to $274 million, despite “significant reductions in patient activity between April and June” due to COVID-19. 90% of the company’s full year revenue growth came from the inclusion of the Imaging Queensland business, which was acquired in November 2019. This implies IDX’s organic revenue growth was only 2% for the year, largely due to a 1.7% increase in average fee per exam.

COVID-19 was a major challenge for the whole sector in 2020. As shown below, the diagnostic imaging (DI) sector’s growth turned negative in March, and ended the 2020 financial year well below the long term average growth rate of 4.7% p.a.

Source: IDX 2020 results presentation
IDX’s EDITDA increased 21% to $64 million, roughly in line with top-line growth, reflecting management’s actions to control an otherwise higher cost base by reducing contractor, employee, occupancy and equipment costs. The company’s net profit after tax grew 22% to $31 million.

A fully franked final dividend of 4 cents was declared, bringing the full year dividend to 9.5 cents which represents a 2% yield.

The company ended the year with net debt of $124 million, up 4% on a year ago.

Indexation

 

From 1 July 2020, all Medicare payments for 90% of diagnostic imaging services became indexed, which means patients will face lower out-of-pocket costs for those services. This development is likely to create a market tailwind in the year ahead and beyond, and shows that the Australian government is aware that investing in diagnostic imaging will save them money elsewhere in the health system.

Sector consolidation activity

 

The diagnostic imaging sector has been a hot spot of takeover activity for some time, and IDX has been both hunter and prey in recent years. For example, Capitol Health (ASX:CAJ) unsuccessfully attempted a $312 million takeover of IDX two years ago. In November 2019, IDX acquired Imaging Queensland which is now largely integrated.

It is a sector where scale and margins are closely related, so further M&A activity is likely. Capitol Health in particular is likely to remain in the market for acquisitions.

Outlook

Whilst COVID-19 has significantly affected the sector in recent months, management flagged that with the exception of Victoria, the rest of their portfolio returned to profitability in July, with particularly strong volume growth (18%) in New Zealand. Indexation will provide a solid market tailwind in the year ahead, while continued demand growth for high-end modalities including MRI and PET will further support the company’s growth.

Valuation

IDX is widely covered by analysts. Consensus estimates have been volatile in recent months, with an initial wave of COVID-related EPS downgrades in March and April, followed by subsequent upgrades over the past three months.

Consensus forecasts are for 21% revenue growth and 53% EPS growth in the 2021 financial year, reflecting the indexation tailwind, followed by more normal 8% revenue growth and 11% EPS growth in the 2022 financial year.

At the current share price of $4.06, IDX is trading on a 2022 PE ratio of 20.4 and a 2022 EV/EBITDA multiple of 10, which represents a modest premium to Capital Health’s 2022 PE ratio of 19 and a 2022 EV/EBITDA multiple of 8. A premium seems appropriate given the high quality of IDX’s assets and management team.

The stock is currently discounting 4% p.a. EPS growth into perpetuity (assuming a 7.5% discount rate) which appears to be more than achievable. The current consensus analyst rating on the stock is Buy.

IDX share price

Source: Metastock, KeyLevels.com – weekly chart with 40 period average.

Conclusion

IDX is a high quality defensive stock. The current valuation arguably understates the company’s strong position in a defensive sector with sustainable tailwinds behind it.

Disclosure: The author does not hold shares in IDX.

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