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  • Writer's pictureGreystone Capital

CRH Medical Corp. (CRHM) Q2 update and thoughts on valuation

I’m surprised and somewhat annoyed by the market’s muted reaction to CRH Medical Corp.’s Q2 results reported on Wednesday night. The business is chugging along as expected, with patient cases increasing at a rapid clip each quarter, and management executing brilliantly in order to increase revenue, acquire new GI businesses, and generate tons of free cash flow. At current levels, shares are still undervalued, and I’ve added slightly to my position despite the stock being up some 60% over the past 9 months from my original cost basis. In surveying the market, I’m just not seeing many opportunities to purchase businesses with high quality management teams for less than 10x free cash flow, growing at a 4-6% clip organically. I understand fears surrounding additional rate cuts (doesn’t appear likely anytime within the next few years), however it appears the market is still undervaluing the cash flow generative nature of the business and focusing instead on GAAP earnings as opposed to free cash flow (high amortization of intangibles due to acquisition based model severely restricts earnings numbers).

The business is moving toward surpassing at the end of 2018 many of the key numbers I modeled for 2019 and 2020 in my original write-up of the business. I couldn’t be happier with how management has performed in the face of rate cuts, growing revenues and adjusted EBITDA by 11% and 14% YoY through Q2 2018.

I guess the only thing to do here is wait until the market wakes up, and realizes that services businesses with steady and predictable revenue, with 40%+ EBITDA margins spitting off tons of free cash don’t trade at multiples of less than 10x that. What is a fair value for CRH? $7/share? $10/share? I’m looking forward to the end of 2018.

Q2 Highlights

  1. Total revenue of $27.3mm, up 31% YoY

  2. Adjusted EBITDA attributable to shareholders of $8.4mm, up 15% YoY

  3. Total patient cases of 66,537, up 44% YoY

  4. CEO Ed Wright stated in the press release: “Lastly, of note and as expected; CMS’ recently proposed 2019 physician fee schedule does not reference any future changes to GI anesthesia reimbursements.”

  5. Free cash flow of $0.10/share for the quarter, $0.26/share for 1H 2018

  6. Reduced share count by around 2mm shares

Here is part of my original free cash flow model for 2018-2020. Notice revenue estimates, patient cases, and estimates of operating and net income.

CRH Model

Based on Q2 and 1H 2018 numbers annualized, it appears that patient cases are going to fall in the 250,000 – 260,000 range for the full year, with revenue coming in at around $85 – $100mm, and operating income in the $16-17mm range. Total Opex are up around 27% as well through the first half of 2018, but with expenses mostly fixed, increases in revenue fall nicely through to EBITDA and operating income.

Free cash flow is still chugging along, with the company generating $0.10/share in the quarter on the back of slightly lower cash from ops YoY due to a slight increase in receivables and higher tax payments, but days sales outstanding are expected to improve moving forward due to removal of payment delays from a change in billing codes in Q1.

As stated by management:

“Impacting the days receivable outstanding as of June 30, 2018 is the implementation of the new CMS billing codes in the first quarter of 2018, which resulted in delays in the processing of payments by payors. This has had a continued impact in the second quarter of the year, but is expected to improve.”

If we annualized 1H 2018 free cash flow numbers (attributable to shareholders) I come up with something in the range of $0.32/share on a $3.45 (USD) share price.

Applying a 15x FCF multiple gets me to nearly $5.00 share price for the back end of 2018. Continued growth in free cash flow will likely drive the multiple and share price higher. Management just needs to continue to execute.

Overall a really solid quarter. The conference call was short and sweet, with questions focused mostly on additional acquisition deal flow and margins.

The most important exchange from the call IMO:

Unidentified Analyst

Hi, hello this is Antonia on the line for Dave. I just got one question and its related to the CMS related cuts that were supposed to have a full impact in January. So have all of those cuts then baked in the 2Q numbers, or are there still some private payors who haven’t yet adjusted down and we can expect those in third and fourth quarter?

Jay Kreger

Based on everything that we’ve seen to date we’ve believe that the cuts announced by CMS have been fully incorporated into all the private payor systems as well as the federal system. So what we’ve seen is what we’ll continue to see.

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