Pro Medicus’ Valuation Predicament

This story features PRO MEDICUS LIMITED, and other companies. For more info SHARE ANALYSIS: PME

Pro Medicus continues to win contacts at an accelerating pace, leaving brokers to raise targets on a promising outlook and simultaneously question a demanding valuation.

-Pro Medicus’ first half profit beat, but revenue missed excpectations
-Market share rises to 9% in the US, margins rise
-First contract win in the cardiology space
-Wilsons’ target based on takeover value 

By Mark Woodruff

Healthcare imaging software company Pro Medicus ((PME)) achieved record revenue and net profit in the first half of FY25, driven in part by nearly $500m in new Visage product suite contracts signed over the past seven months. The level of new contracts exceeds the total secured in the previous three years combined.

Co-founder, Managing Director and CEO Dr. Sam Hupert highlighted in the earnings call Pro Medicus’ competitive edge over rivals whose solutions are not fully cloud-based, alongside its patented thin-streaming technology, which delivers superior study recall speed.

These advantages allow the company to command a significant price premium over competitors. Importantly, the cloud-based picture archiving and communication system (PACS) market is growing at 15% per annum, highlights Morgan Stanley, outperforming by 6% growth for on premise alternatives.

While Morgans raises its 12-month target price, and notes key forward metrics continue to look strong, it remains hard for this broker to justify the current valuation. Morgans. of course, is far from the only one.

For years, Pro Medicus’ valuation has perplexed many, points out Wilsons. This broker believes the shares likely embed a premium for corporate appeal to the likes of Philips, GE, and Siemens, relating to an eminently scalable platform across global radiology.

First half results 

Underlying profit for the half beat the consensus expectation by 1%, but revenue missed by -2% largely due to timing of contract implementations.

Revenue from ordinary activities rose by 31.1% to $97.2m, aided by a 34.6% increase in North American revenue to $86.4m.

Current market share in the US market is around 9%, up from 7% in August, helped along by the largest ever contract win of $330m over ten years with Trinity Health, and the signing so far in FY25 of seven new contracts worth $57m per year in revenue.

European revenue was flat compared to the previous corresponding period, while Australia continues to grow modestly but remains immaterial to earnings, points out Wilsons.

Crucially, the company continues to enjoy strong EBIT margins, improving by more than management expected to around 72% from 66% at the same time last year, largely due to a step-up in transaction revenue.

Transaction growth from existing clients increases at around two-to-three times the industry average, thanks in part to productivity improvements delivered by the company’s Visage platform, explains Bell Potter.

At a time when a global shortage of radiologists is showing no sign of abating, hospitals and medical centres are seeking productivity gains.

Management continues to win new business in the traditional client base of Academic Medical Centres and Independent Delivery Networks. However, the recent win at Duly Health in the Private radiology segment is pivotal, suggests Bell Potter.

This broker points out consolidation in Private radiology (the segment with the lowest-margin work) creates organisations of sufficient size for Pro Medicus to now bid on requests for proposals, increasing the company’s total addressable market (TAM).

Management believes around 85% of the US TAM is addressable by Pro Medicus, with this share expected to increase as smaller players are consolidated.

Rising by 17.7% during the half, cash and other financial assets reached $182.3m, and a fully franked interim dividend of 25 cents was declared.

Rising margins

Citi believes the earnings margin will continue to expand as revenue growth outpaces growth in operating expenses. Indeed, Wilsons assesses a subtle change by management in not fighting suggestions margins should expand further from here.

The analysts attribute the recent margin increase to the accelerated pace of contract wins with larger clients, without much incremental investment.

Looking forward, the first cardiology implementation will ‘go live’ this coming April after management signed its inaugural contract for the full Cardiac-Echo package.

Cardiology will generate nearly twice the margin of radiology (though the TAM is about 20% of the radiology opportunity), and this first customer bodes well for more activity, suggests the broker, given several loyal accounts have been involved in helping develop the end product.

Valuation

Helping explain the premium valuation for Pro Medicus, Goldman Sachs highlights a best-in-class SaaS margin by comparison to global peers, as well as 71% achieved under the Rule of 40 metric, leaving second placed Veeva Systems Inc floundering in relative terms at 49%. 

US-based Veeva is a leading provider of cloud-based software solutions for the global life sciences industry.

For an ASX comparison, WiseTech Global ((WTC)) and TechnologyOne ((TNE)) are third and fourth at 44% and 40%, respectively, measured against the Rule of 40, which combines revenue growth with the free cash flow (FCF) margin percentage.

A global margin comparison is even more striking, with Pro Medicus above 70%, while Oracle and Adobe are at 42% and 37%, respectively.

Interestingly, Wilsons prices Pro Medicus as a takeover target and uses gross profit dollars to an acquirer, rather than free cash flow (FCF) to the company, as its valuation method of choice.

A less bullish Citi suggests the current valuation implies even greater growth than the broker’s forecast FY24-30 EPS compound annual growth rate (CAGR) of 31%, which will become more difficult to achieve over time partly due to market share limitations.

Outlook

Following an unprecedented amount of contract conversions over the last two months, management notes a strong pipeline replenishment, and Morgan Stanley believes Pro Medicus is best suited to win in new adjacencies.

Following first half results, the average target in the FNArena database jumped to $242.25 from $210.92, with targets ranging from Bell Potter’s $330 to Ord Minnett on $140 (research not updated). 

Bell Potter upgraded to Buy from Hold, joining Morgan Stanley at Buy (equivalent), leaving two daily monitored brokers on Hold and two with a Sell rating.

Outside of daily monitoring, Goldman Sachs has a Buy (target $309), and Wilsons joined Moelis on Hold after downgrading from Buy on valuation and raising its target to $297 from $275. Moelis’ prfice target is $285.60.

RBC Capital rates the stock Sector Perform with a $295 price target.

The author owns shares in Pro Medicus.

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