This morning, radiology software company Pro Medicus (ASX: PME) reported its results for H1 FY 2025 and in response, the share price has dropped around 3.2% from $288.31 to $279.08 at close. Half-year earnings per share was 49.5 cents, so you know that this high quality stock is well-loved by the market.
The Pro Medicus H1 FY 2025 net profit after tax came in at $51.8 million up 42% and revenue from customers grew 31% to $97.2 million. Revenue from interest received was up 67% to $3.6 million reflecting the company’s growing cash and financial assets now worth over $182 million. Free cash flow was $44.5m, a whopping 86% of net profit after tax.
You can see how Pro Medicus has grown profit over the years, in the graph below.
The main driver of this growth has been revenue from North America. As you can see in the chart below, revenue from north america grew about 13% half on half, which is towards the lower end of the normal range.
I have long expected half-on-half revenue growth from the US to moderate, but the growth rate has proved more resilient than I expected, even in the face of increasing scale. Generally speaking, growth rates moderate over time as maintaining growth rates requires continuously larger growth at an absolute level.
Record Result For Pro Medicus Contract Wins
I expect Pro Medicus to produce a strong revenue and profit performance in H2 FY 2025 and H1 FY 2026 based on the record amount of contracts signed during the half, including the record $330m 10 year contract with Trinity Health. The CEO emphasised that this level of success relied on luck since the company does not control when contracts are signed. He made the point that good fortune meant that H1 FY 2025 was an unprecedented sales result in the history of the company. To quote the report:
“During the period Pro Medicus won key contracts with Trinity Health, Lurie Children’s Hospital and Duly Health and Care. These contracts were for a combined minimum amount of $365 million spread over 7-10-year deals. In addition, the company renewed contracts with Mercy Health in the USA ($98 million, 8 years) and with a large Australian radiology practice ($32 million, 5 years). Additional modules were also added to existing contracts at both Duke Health (archive addition, $15 million, 5 years) and NYU Langone (archive addition, $24 million, 5 years).”
Notably, the contract wins have continued since the end of the period with a $33m 9-year contract and a $53m 7-year contract announced in January and February, respectively. When it comes to new contracts, Pro Medicus has been having a very successful time lately, and this has understandably depleted the pipeline to some degree. When quizzed about this on the earnings conference call, Pro Medicus CEO Dr Sam Hupert said that Pro Medicus had attracted some new leads at the recent RSNA and they were very happy with the replenishment rate of the pipeline.
Traditionally, Pro Medicus has lower EBIT margins in the first half because that half bears the cost of the big RSNA conference. However, in the H1 FY 2025 result, there was only a very slight half-on-half decline in EBIT margins, and this bodes very well for the proposition that the FY 2025 result will once again demonstrate record profit margins.
Part of the reason for the strong margin performance in H1 would likely be the rapid implementation of the Baylor, Scott & White contract.
In my coverage of the FY 2024 results I noted that this was scheduled to complete in September 2024. However, the company has since said it only took 11 months to implement this contract. Given that the contract was signed in September 2023, I take this to mean it was implemented up to a month ahead of schedule.
Clearly, the strong implementation track record is a great competitive advantage for Pro Medicus, and the CEO commented:
“We keep refining our implementation methodology which we believe is the best in the business bar none. We learn from each one we do, and whilst no two are alike, the more we do the more commonality we find… the sooner the client is fully live, the sooner we get the full run-rate of revenue going forward.“
Sociological Observations About The Pro Medicus Stock Price
From what I can see bearish arguments against the stock seem to be getting weaker and while they always lacked bite they now also lack venom. One investor, who I consider a contra, and use to gauge market sentiment, only repeated the same criticism he had made years ago when the shares were a tenth of the price. I believe this zeitgeist is also reflected in the reduction of short interest in the stock. You can see that short interest has fallen from above 5% a couple of years ago to below 1.5% today, in the chart below from Shortman.
At the risk of stating the obvious, but counterintuitively for some, it is actually a good thing for long-term shareholders like myself when Pro Medicus has a high short interest because that means more people will have to buy shares in the future. Conversely, it’s a slight negative when short sellers are scarce because that implies buoyant sentiment and less of a coiled spring under the share price, and indeed, the potential for short sellers to depress it by initiating new positions.
Be warned, though, that this logic only holds for a precious few high-quality stocks like Pro Medicus and certainly does not extend to stocks like AMC Theatres.
Finally, there are still 15 broker analysts covering Pro Medicus on S&P Capital IQ. Analyst estimates for revenue in FY 2025 ranged from around $203m to a whopping $227m. Once you include the interest income, total revenue for H1 was about $100.8m, so I would expect that the full-year result should come in at or (probably) above $210m, and this suggests short-term expectations are not unreasonable.
Of course, it is the long term that really matters, and I don’t think short-term analyst estimates matter except to help us understand what others are thinking.
Pro Medicus Share Price Valuation
Late last year, a supporter requested a comment on the Pro Medicus valuation due to the strong share price run after the FY 2024 results. At that time I wrote:
“It is very hard to argue it is cheap… [but] there is no doubt that Pro Medicus is a high-quality company, and I think it is the best quality stock on the ASX. It has honest, competent and aligned management. But it also has its work cut out to grow into its current valuation over the years to come… Given the optimism implicit in the share price, I think that it is pretty reasonable to trim the position at a share price above $200, and I will likely do so in the future.”
After that, I did indeed take some profits at prices from $230 to $290, and even though the company is growing in value, the Pro Medicus share price still seems very optimistic to me.
For example, if you took the half-year profit of $51.8m, and assumed that profit grows almost 20% half on half to $60m, then you would get a FY 2025 profit of $111.8m. At the current Pro Medicus share price of about $279, the company has a market capitalisation of over $30.1 billion.
That means that based on my back-of-the-napkin guess at FY 2025 profit, the stock trades on a P/E ratio of almost 270. That means the profit needs to 10x from here before profit growth fizzles out in order to justify the current price. As a result, it is certainly hard to believe that we won’t see a cheaper price for Pro Medicus shares at some point, and I may continue to trim my position around these levels.
Despite my inclination to take profits, Pro Medicus is still my second-largest position. My attitude is to always ensure my portfolio is skewed towards the highest quality businesses with honest and competent management, and given Pro Medicus scores so well in this regard, I like to maintain a high allocation to the stock.
That said, my recent trimming of Pro Medicus shares means that my largest position has now become the small, profitable, well-run software stock I highlighted in this recent Supporters-only article.
After having Pro Medicus be my largest position for the best part of a decade, having a new “largest position” certainly feels like a new chapter in my investing journey.
Disclosure: The author of this article owns shares in PME and will not trade PME shares for at least 2 days following the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Ethical Investment Advisers Pty Ltd (ABN 26108175819) (AFSL 343937).
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