"The presence of lower prices, not surprisingly, is frequently associated with a relatively poor, near-term outlook for an industry, company or country," wrote Matthew Fine and Michael Fineman of Third Avenue Value Fund. "So this approach [bargain stock shopping] requires a multi-year investment horizon."
The description above of the relationship between cheap price and business outlook, nicely describes why I bought Mednax, Inc. (MD on Nyse) this week. In this essay, I describe the key reasons for the gloominess for the U.S health care and how they drove down the price of Mednax.
Mednax and peers now face three uncertainties. First is U.S. Government's tracking of medical costs which force hospitals to disclose prices. Read more under the Centers for Medicare and Medicaid Services' price transparency law. From health-care companies perspective, hospitals, their customers, are becoming price-conscious buyers, which will hurt future earnings.
The second concern comes from the The Affordable Care Act (ACA) which contains provisions such as establishment of health insurance exchanges that adversely affect the earnings of health-care companies (unsurprisingly the ACA risk is listed second in the risk factors section of the MD's annual report.)
The third worrisome trend is that businesses are taking health insurance costs to their hands. CNBC reports that Amazon, Berkshire Hathaway and JP Morgan partnered to improve health care for their 1.2 million employees. Branded under the name Haven, their partnership aims to "create new solutions and work to change systems, technology, contracts, policy and whatever else is in the way of better health care."
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Yet it was not only uncertainty fear that halved the price of Mednax over the past year. The drop in price was also because of the company's own doing. This is because pre-tax earnings and net earnings fell each year since 2015.
Four years ago Mednax reported $599 million in pre-tax earnings and $336 million in net earnings. In 2018 it reported $468 million in pre-tax earnings and $268 million in earnings.
Also of concern is that Mednax has been increasing the right side of the balance sheet. In 2015 for every dollar of equity it carried 86 cents of liabilities. But as of the first quarter of 2019 Mednax reported that for every dollar of equity it carried a dollar and five cents of liabilities.
And management's appetite for leverage is clearly noticed if we use a wider (time) lens. In 2009 total liabilities to total assets ratio was 30%; the ratio increased to 37% in 2014 and to 48% in 2018. It is now 51%.
So given the gloomy U.S. health care industry landscape and the company's lackluster operating performance, Mednax share price today should be lower than it was a year ago.
But how much discount should we require? a price tag of $22 was enough for me to buy the stock. In the remaining part of this essay, I explain why.
In 2018 Mednax reported on revenue of $3,647 million. Now its market capitalization is $1,820 million. In other words Mednax now trades at about half the 2018 revenue. More impressing, perhaps, is the fact that over the past decade Mednax market capitalization was never below the company's prior year's reported revenue.
The highest premium was 1.56 times in 2010 and the lowest premium was 1.1 times in 2017. To put in perspective, even in 2009, in the Great Recession, Mr. Market valued Mednax at 1.3 times its revenue.
The same argument, of current valuation significantly below the historical valuation, can be seen by glancing at the balance sheet too. At $22 per share Mednax is trading at two thirds of the book value as of its most recent filing.
This is a ten-year low as during the past decade Mednax shares traded at premium to book value. The 10-year average range premium to book value was as low as 0.95 times and as high as 3.27 times.
Without diluting shareholders (there were 92 million outstanding shares a decade ago while today there are 89 million shares), management had done reasonably well in increasing its revenue resources.
The number of physicians increased by 11% compounded annually, from 1,484 physicians in 2009 to 4,213 physicians in 2018. And the number of anesthesia operations increased by 22% compounded annually, from 244,127 in 2009 to 1,844,451 in 2018.
Over the past decade, revenue increased to $3,647 million from $1,288 million and reported assets grew to $5,706 million from $1,689 million. And the company's boss and co-founder, Roger Medel, still holds 1.6 million of the outstanding shares.
On page 2 of the quarterly report to shareholders, the portfolio managers of Third Avenue summarize their portfolio: P/E ratio is 12 times. Price to book is 0.87 times. Price to sales is 1.05 times. And price to cash flow is 5.83 times.
Mednax, at current valuation, would nicely fit their portfolio: P/E ratio is 8 times. Price to book value is 0.74 times. Price to sales is 0.60 times. And price to cash flow is 7 times.