Medical Facilities Corp. (TSX:DR, Financial), (OTCPK:MFCSF), in partnership with medical doctors, owns a portfolio of surgical facilities in the United States. Its ownership includes controlling interest in four specialty surgical hospitals located in Arkansas, Oklahoma and South Dakota, and an ambulatory surgery center ("ASC") located in California. In addition, through a partnership with NueHealth LLC, Medical Facilities owns a controlling interest in five ambulatory surgery centers located in Michigan, Missouri, Nebraska, Ohio and Pennsylvania. The company also owns non-controlling interests in a specialty surgical hospital in Indiana and an ASC in Missouri.
The specialty surgical hospitals perform scheduled surgical, imaging, diagnostic and other procedures, including primary and urgent care, and derive their revenue from the fees charged for the use of their facilities. The ASCs specialize in outpatient surgical procedures, with patient stays of less than 24 hours. Even though the company's business is entirely in the U.S., it is listed on the Toronto stock exchange.
Medical Facilities is an interesting investment as there is a large, growing and fragmented market for outpatient services in the U.S. that presents a scalable platform for growth – organically and via acquisitions. However, the company has not demonstrated consistent growth over its existence. Demographics are favorable as the U.S. population is aging, meaning more health care services. However, the company has struggled over the past three years due to a poor acquisition, which destroyed value.
As a result, the company was forced to take a large impairment charge in 2019 and cut its dividend as its payout exceeded its cash available for distribution. Then Covid hit, decimating elective surgeries in 2020. While the stock has bounced from the March 2020 low, it is still a long way from the highs reached in 2017. The problematic facility was sold off in 2020 and company appears to be coming back to form. Regardless, the share price is still quite low.
Complex structure
The company has a complex operating and capital structure. It is a cross between a partnership and a corporation. Medical Facilities partners with the doctors and surgeons in its facilities, with the latter taking a minority position as minority owners in the facility. The hospitals and surgical facilities are subsidiaries that roll up to the parent company.
Accounting is not straightforward. Minority owners (i.e., the surgeons) get their income at the facilities (hospital) level before corporate-level expenses, such as interest on debt, are deducted. Thus, the minority shareholders are like super-preferred equity since they get paid not only before the common shareholders, but before many corporate level expenses. The minority interest is recorded on the balance sheet as a hybrid security, i.e., between debt and equity. Minority ownership is convertible into common shares at the option of the minority owner according to a formula established when the facility was acquired. As the balance sheet below shows, debt is reasonable.
Cash available for distribution
The company presents a financial metric called "cash available for distribution," which is similar to free cash flow. I have collated this measure over the last six years as follows:
2020 | 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | Average | |
Cash available for distribution - '000 C$ | 40,005 | 27,533 | 48,822 | 51,710 | 50,655 | 45,853 | 41,366 | 43,706 |
Cash available for distribution per common share - C$ | 1.286 | 0.886 | 1.575 | 1.668 | 1.631 | 1.466 | 1.32 | 1.40 |
The following table illustrates for how the metric is calculated:
Source: Medical Facilities filing.
Valuation
In valuing Medical Facilities, I used the seven-year average of distributable cash per share, which came to $1.40 per share, as input in the GuruFocus discounted cash flow calculator. I used a discount rate of 8% and a growth rate of only 2%. I generated a value of $16.21. The company appears to be significantly undervalued on a conservative basis. Of course, the major assumption is that over the next few years, the company will be able to bounce back to normalized cash generation.
Conclusion
Medical Facilities appears to be substantially undervalued and has a good margin of safety. The company should see a substantial rebound in surgical volume in the coming quarters as the economy recovers from Covid-related lockdowns. In the past, the company paid out almost all its cash as dividends. However, it has cut its dividend (currently ~3.8%) and is retaining most of the cash in an attempt to demonstrate growth by reinvesting. The question is, of course, whether it will able to make good acquisitions without overpaying. If the company can do that, the market will likely rerate the shares substantially. My target is 14.50 Canadian dollars (US$11.97) in three years, which would be a 100% gain from here.
Disclosure: The author owns shares of Medical Facilities Corp.
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