Small Caps | Feb 13 2014
-Strong specialist sales capability
-Well placed to expand product offering
By Eva Brocklehurst
LifeHealthcare ((LHC)) is a distributor of high-end surgical equipment, prostheses and medical consumables. The simple business structure in a specialist field appeals to brokers as it provides considerable margin and revenue from sales to public and private hospitals as well as specialist medical practices. The company listed on the ASX in December, with the sell-down of a private equity stake.
For Bell Potter, which has recently initiated coverage of the stock, the simple business model belies a complicated intellectual property base. The major point of difference is the company's highly trained sales staff which provide support capability for the complex medical devices the company distributes. This leads to strong relationships between the company and the medical profession, providing significant barriers to new entrants or to a supplier that may wish to change the distribution model and deal direct rather than via LifeHealthcare as an agent.
Bell Potter has a Buy recommendation and $2.60 price target. UBS also initiated coverage last month with a Buy rating and $2.30 price target. UBS also likes the strong relationships with both the suppliers and medical profession. The broker thinks the company has secured an opportunity to take advantage of global niche medical manufacturers without direct Australian distribution that need to gain access and scale, and are willing to trade margin for this.
Another fact that brokers like is that distribution of specialised products is a highly fragmented industry in this country. This means the company has the opportunity to expand either by acquisition or finding new suppliers. Bell Potter notes that large multinationals, the company's biggest competitors, tend to directly supply where the revenue can support fixed cost bases. Smaller such suppliers tend to use distributors and this is where LifeHealthcare comes to the fore.
LifeHealthcare is also fortunate to be well placed in a market that is growing strongly as the population ages. This means more call for replacement devices and implants – hip, knee you name it – as well as surgical intervention. Moreover, the business is catering to niche areas, where value is delivered through well trained sales specialists and responses to client requests, such as for new products or instruments. Spinal surgery is one area of specialisation and represents 35% of the company's business. UBS thinks this is a point of sensitivity and the company could secure further upside to earnings forecasts if it grew the product range by contracting additional devices. LifeHealthcare has distribution agreements with more than 60 suppliers, the majority from offshore. Contracts are usually for three to four years.
Risks lie in factors that may affect demand for medical services delivered in hospitals, such as product obsolescence, although Bell Potter contends this risk is low given the lengthy development pipeline for new product and the risk averse nature of the medical community. The main risk is product liability. LifeHealthcare has product indemnity written into all supplier contracts which the broker thinks is very important, given the increased number of such liability cases arising form failed medical devices and implants in the US.
The company does not plan an interim dividend but will pay a final dividend based on earnings from January to June 2014, likely to be partly franked. The company expects a dividend pay-out ratio between 50-70% over the longer term. Bell Potter cautions that earnings have potential to be significantly affected by movements in the value of the Australian dollar and a weaker dollar is unhelpful in the longer term.
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