This morning, radiology software company Pro Medicus (ASX: PME) reported its results for the FY 2024, and in response, the share price has gained 9% from around $131 to over $142 at the time of writing.
This market interaction with the results in some ways mirrors the negative response to the Pro Medicus H1 FY 2024 results, which saw the Pro Medicus share price drop as flighty shareholders abandoned the stock in droves, before the share price growth resumed as superannuation funds (I assume) resumed ramming the share price higher. What remains consistent is that the business itself produced record revenue and record profit. To wit, in H2 FY 2024 revenue was up 28.5% to $87.4m million and the full year revenue was up 29.3% to $161.5 million.
When I covered the H1 FY 2024 results, I wrote “The main things I would like to see in the second half are improved cash conversion, improved half on half revenue growth from North America and improved or flat EBIT margins (relative to the PCP)”. All these things were achieved in the FY 2024 results.
In H2 FY 2024, Pro Medicus net profit after tax came in at $46.5m up 39% on H2 FY 2023. For the full year FY 2024, Pro Medicus achieved net profit after tax growth of $82.8m, up 36.5%.
While not necessarily a better guide, I have always tracked net profit less the impact of currency gains and hedges. On this adjusted measure, Pro Medicus achieved a record result in H2 FY 2024, boasting particularly strong half on half growth, as you can see below.
Part of the reason for the faster absolute growth was that the H2 FY 2024 EBIT margin came in at over 72% based on underlying EBIT. That is up on the corresponding H2 FY 2023 underlying EBIT margin of 68.6%. All else being equal, the expenses associated with the large RSNA conference occurring in the first half of the financial year will ensure that the first half EBIT margin is usually lower than the second half EBIT margin, and it would completely normal for Pro Medicus to produce a weaker margin in H1 FY 2025 than it did in H2 FY 2024. The company should have a strong H1 FY 2025, however, with Pro Medicus CFO Clayton Hatch commenting on the conference call that the implementation of the huge Baylor contract started in June, and will be complete by September 2024. As you can see in the chart below EBIT margins have generally improved over the last few years. In any event, the longer-term trend is for improving EBIT margins.
I noticed on the conference call that analysts are starting to try to goad management into promising improving margins. However, management seem to prefer to avoid promising margin improvements in case costs need to grow. However, there is a risk that manaagement’s non-promise of margin improvements will be disrespected by naughty analysts who then go on to overestimate profit, thus upsetting the psychological wizardry that keeps things positive. And then the cycle repeats.
“Inconstancy is my very essence,” says the wheel. “Rise up on my spokes if you like, but don’t complain when you’re cast back down into the depths. Good times pass away, but then so do the bad.“
A Sociological Snapshot Of The Pro Medicus Share Price
On a sociological level, I believe the share price gain today is more a reflection of a lot of hot money rushing back into Pro Medicus, probably because it beat analyst estimates on net profit after tax. I also suspect that the analysts who were disappointed by the H1 EBIT margin and lowered their price targets, will now justify increased price targets due to increasing EBIT margin predictions based on the H2 FY 2024 EBIT.
I have now covered every single set of Pro Medicus results for 9 years, since I first recommended the stock to subscribers of Motley Fool Hidden Gems in March 2015 at around $1.50. I have found that the number of analysts covering the stock has been a far more useful data point than the actual numbers analysts expect it to report next year. These days, the share price does respond to company performance vis-a-vis analyst forecasts, so analyst forecasts are relevant in that regard. However, I also think that the number of analysts covering the stock is also an interesting guide since it shows how immensely popular it has now become. When I first recommended the stock, zero broker analysts followed the company.
A Note On Pro Medicus Analyst Estimates
To wit, there are now 15 analysts submitting forecasts to S&P Capital IQ. On average they had expected NPAT of about $80m, around 3.5% below the actual result. With luck the legendary Hupert and Clayton duo will be able to emit enough conservatism to ensure that analysts continue to underestimate the company. But managing analyst expectations is the work of wizards and quite frankly I prefer just check out of the whole “analyst estimates” mental framework, because I feel that knowing what other experts think clouds my own judgement. On this one stock, if none other, I feel I should back myself.
Personally, I feel the market is ignoring the fact that meaningful revenues from cardiology (as opposed to radiology) and artificial intelligence are a long way away. Indeed, on the conference call, the CEO of Pro Medicus, Dr Sam Hupert, commented that:
“Cardiology is a brand new product for us; it’s where Visage was 10 years ago. There are statutory requirements to report the outcome to a central body. And you need that bit to be useful. I think we’re getting closer to version 1.0.”
On the subject of the artificial intelligence research, Dr Hupert commented that:
“We need the projects we’re working on to have plenty of clinical valuation. It’s taking us a touch longer than we thought.”
Please note, however, that Dr Hupert has steadfastly avoided giving any timelines to artificial intelligence product revenue, wisely acknowledging that the speed at which cutting edge technologies are adopted depends on a large multitude of factors outside his control. So while I fear analysts may become disappointed in the future, I don’t think that is the fault of management, who I believe are very responsible with their statements.
However take a moment to pour one out for the market monkeys who sold Pro Medicus after a 1% miss to earnings in the H1 FY 2024 results, only to see the share price ~60% higher after this equally moderate 2.8% beat to earnings. They are probably buying now! (I’m joking; I have no idea who is buying).
Pro Medicus North American Revenue
As the (two? three?) readers who have followed my coverage since 2015 would know, I always take a look at Pro Medicus’ North American revenue growth rate to get a feel for underlying half on half underlying growth. For this measure, I ignore the Australian RIS revenue because it is a lumpy license model, and it has already saturated its market, so it can’t really grow like the North American market can. Pro Medicus says it has 7% of the North American market in scan volumes. It says 15% will never be potential customers, but that leaves another 78% of the market for the taking. So it has plenty of room to grow.
Long-serving Pro Medicus CFO Clayton Hatch pointed out that the penetration was higher in academic hospitals, where Visage made its early headway. I suspect this is a cheeky mental nod to the fact that many of the next generation of radiologists are being trained on Visage 7, but since I’m speculating about his mindstate, I couldn’t possibly confirm. Perhaps something they could add to their list of competitive advantages.
In any event, as you can see above, the H2 FY 2024 half-on-half revenue growth was around 20%, in line with recent years.
Pro Medicus Free Cash Flow And Balance Sheet
In FY 2024, Pro Medicus produced free cash flow of $74.8m (defined as operating cashflow less capex, capitalised development costs, and lease repayments). This was a 90% conversion rate of NPAT to free cash flow. This result is consistent with the FY 2023 result of 92%. This is an impressive conversion of net profit to free cash flow, though some luck likely played a role. Pro Medicus has experienced lower conversion rates in the past, so it’s important to remember that these numbers can fluctuate due to the timing of payments and receipts.
The balance sheet remains very healthy with cash and conservative investments worth $155.4m.
Pro Medicus Growth Outlook
During the half year, Pro Medicus announced a huge number of new contracts. The company is also emphasising that the threshold for a market sensitive contract has obviously increased over the last few years, so it may not announce contracts or renewals that, in the past, it would have announced. So far, retention rate is at 100% and the CEO confirmed on the call that no customers had been lost from the pipeline to a competitor, in the last year. You can see below how FY 2024 has been an enormous outlier in terms of number of contracts announced. I do not expect every year to be so phenomenal.
On the conference call, Pro Medicus CEO Sam Hupert mentioned that it wouldn’t make sense for Consulting Radiology Limited to take the full stack product since, as purely consulting radiologists, they do not store the image. Rather, that is stored by the hospital group or integrated delivery network.
One analyst cleverly asked whether Pro Medicus had much hope of getting any of the top 10 large hospital groups, seemingly fishing to find out more information about the pipeline. This question yielded results when the CEO coyly commented that, “we do have opportunities across all segments of the market.” This does imply some very large hospital groups might be possible opportunities. However, the CEO hastened to add that some very large hospital groups are “really difficult and they often don’t settle on one supplier,” so I think we should temper expectations for mega contracts like Baylor, Scott & White Health. If and when they come they may not be for the full volume across the network. Furthermore, it seems likely these large groups will be slow to uptake new technology, as they may be more bureaucratic due to their large size.
Pro Medicus Shares P/E Ratio And Sociological Signal
After the half year result Pro Medicus traded on a trailing twelve month P/E ratio of 141. In FY 2024 Pro Medicus earned 79.1 cents per share and at the time of writing the share price is around $142, putting the Pro Medicus trailing twelve month P/E ratio at about 179.5. This is high, even for Pro Medicus.
In my coverage of the Pro Medicus H1 FY 2024 results I made a sociological observation, noting:
“While the current share price is above my official desired price based on an attempt at estimating value, I have recently noticed a sociological signal that is telling me to buy Pro Medicus shares. While this conflicts with my rational brain, at a high level the argument would be the evidence of someone else’s schadenfreude is an indication of an irrational negative sentiment in the market. Then, the impulse would be to act against that irrationality. Previously, I let this same person impulse me into buying shares in PME… in March 2020. It was actually pretty well timed.
I guess an anecdote of once doesn’t prove anything.
Nevertheless, this thought disposes me even less to the idea of selling. Rather, I’m more wondering how low sentiment can go. In hindsight, there were multiple times I should have paid up for PME…”
Today, with the share price some 60% higher, that same sociological signal that was telling me to buy Pro Medicus has fallen silent. To me, that indicates that sentiment around the stock is positive… maybe too positive.
Conclusion On The 2024 Pro Medicus Results
In conclusion, I still think Pro Medicus is the highest quality business on the ASX. I think that the management team, employees, and board are among the best and most honourable you will find operating on the ASX. It has been the largest stock in my portfolio for a very long time. However, considering that PME shares currently make up over 17% of my ASX portfolio, and my highest conviction idea right now only makes up around 8% of my ASX portfolio, I am thinking I will reduce my shareholding in Pro Medicus a little. That means I will wait 48 hours from publishing this article, and sell a small amount of my position any time from 3.30pm Friday, 16 August.
I still intend for Pro Medicus to remain the largest stock in my portfolio, after I reduce my position size slightly.
The words I wrote in March 2015, when I first recommended Pro Medicus, still hold true today:
“Visage is an essential part of medical diagnosis, and the company is positioned to benefit from increased volumes as the population ages. It saves time for doctors, increasing their efficiency, thus reducing costs of the medical provider.”
It couldn’t be clearer that the shortage of radiologists is driving super profits for Pro Medicus. On the conference call today, the CEO mentioned that they thought they could make radiologists 25% more efficient. Given radiologists have such a high hourly rate, that’s a big deal. Furthermore, the Visage Ease product, which allows remote diagnosis (and the use of Apple’s virtual reality goggles) makes life easier for those radiologists who use Visage.
With sky-high margins, highly honest and competent leadership, significant recurring revenue, and plenty of room to grow, Pro Medicus is an essential inclusion in my portfolio, despite the optimistic valuation.
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Disclosure: the author owns shares in PME and will not trade PME shares for 48 hours following the publication of this article. This article is not intended to form the basis of an investment decision. 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 Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937).
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