- A long position provides approximately a 99% chance of 20% return or higher.
- PINC is the strongest performer in generating economic value, relative to peer set.
- Investors have a rare opportunity to get in early before the market prices in the company’s strong economic position.
Premier, Inc. (PINC or "the company") operates as a healthcare alliance that unites hospitals, health systems, physicians, and other healthcare providers in the United States.
Based on our Economic Value model and Monte Carlo simulation, our probability distribution of "fair value" for PINC affirms that the intraday share price of $32.32 is undervalued (as of 4/2/2014). The estimated expected value of the share price based on the mean and median is $47.12 to $47.01, respectively (Table 1).
Table 1: Monte Carlo Simulation - Statistics
Due to the company's limited history as a publicly traded company, we took a fairly conservative outlook relative to its most recent performance and its peer set. However, despite a deliberate pessimistic forecast, the company's stock price shows significant upside potential (Figure 1).
Figure 1: Historical Share Price and Forecast
Consequently, the probabilities of realizing a 20% return from either a long or short position is as follows (Table 2):
- Long: approximately 99% chance of 20% Return or Higher. 0% chance of a loss.
- Short: approximately 0% chance of 20% Return or Higher. 100% chance of a loss.
Table 2: Monte Carlo Simulation Probabilities
ECONOMIC VALUE PERFORMANCE AND DRIVERS
PINC initially came to our attention through our Economic Value ranking (Table 3). Not only does the company impressively generate the most Economic Value in absolute dollars, it also ranks the highest after adjusting for both size in Capital (27.2%) and Revenue (15.9%).
Table 3: Economic Value Ranking
(Table 4) Although Revenue Growth is about near the median (5.3%), PINC's Economic Value has been driven by its exceptional ability to generate a high Return on Capital (35.7%).
Table 4: Drivers of Economic Value
(Table 5) The company's high Return on Capital is a function of impressive NOPAT Margin (20.9%) and respectable Capital Turns (1.71x).
Table 5: Drivers of Return on Capital
However, despite the company's exceptional ability to create value, market expectations still lag. We presume that limited investor recognition is the culprit, given that PINC only became public in September of 2013. Market expectation can be observed through Market Value Added (MVA), which is the Market Value (Debt plus Market Value of Equity) less the Capital invested, and represents shareholders' expectations of the future stream of Economic Value or Discounted Cash Flow (DCF) after deducting the capital invested. Mathematically the Net Present Value of a DCF is always equal to the Present Value of Economic Value. Consequently, we can calculate the Implied Economic Value Growth in MVA (Table 6) embedded in the current share price. PINC's Implied Economic Value Growth in MVA is approximately -50.1%, which is at the low end relative to peers. The good news is that it will take very little for the company to exceed market expectations.
Table 6: MVA and Economic Value Ranking
Note: The peer set selected is from a universe of companies based on S&P Capital IQ's Health Services industry classification. Where possible we include up to 30 peers in order to get a better statistical sample. For this analysis our peer set includes: Addus HomeCare Corporation (NASDAQ:ADUS), Air Methods Corp. (NASDAQ:AIRM), Alliance Healthcare Services, Inc. (NASDAQ:AIQ), Almost Family Inc. (NASDAQ:AFAM), Amedisys Inc. (NASDAQ:AMED), AMN Healthcare Services Inc. (NYSE:AHS), Bio-Reference Laboratories Inc. (NASDAQ:BRLI), BioScrip Inc. (NASDAQ:BIOS), Catamaran Corporation (NASDAQ:CTRX), Chemed Corp. (NYSE:CHE), CorVel Corporation (NASDAQ:CRVL), Cross Country Healthcare, Inc. (NASDAQ:CCRN), DaVita HealthCare Partners Inc. (NYSE:DVA), ExamWorks Group, Inc. (NYSE:EXAM), Express Scripts Holding company (NASDAQ:ESRX), Gentiva Health Services Inc. (NASDAQ:GTIV), Healthways Inc. (NASDAQ:HWAY), IPC The Hospitalist company, Inc. (NASDAQ:IPCM), Koninklijke Ahold N.V. (NYSE:AH), Laboratory Corp. of America Holdings (NYSE:LH), Landauer Inc. (NYSE:LDR), LHC Group, Inc. (NASDAQ:LHCG), MEDNAX, Inc. (NYSE:MD), National Research Corp. (NRCI.B), Omnicare Inc. (NYSE:OCR), Premier, Inc. , Providence Service Corp. (NASDAQ:PRSC), Quest Diagnostics Inc. (NYSE:DGX), and Team Health Holdings, Inc. (NYSE:TMH).
Although past performance is not always indicative of future performance, historical data can provide a good estimate of the range of possibilities. The ranges we use for our key drivers of Revenue Growth, Spread, NOPAT Margin and Capital Turns represents our 90% confidence interval. For each scenario of our valuation, a random value is generated for the drivers of our discounted Economic Value model (Figure 2).
Figure 2: Overview of Economic Value and Monte Carlo Simulation
These random values are based on reasonable ranges derived from Trailing Twelve Month (TTM) 10-year historical distributions of company and peer data. While point estimates are often "precisely wrong," range estimates provide a more realistic view of market variability and have a greater chance of the actual outcome falling within the estimated range. Additionally, we scrutinize the inputs of our Monte Carlo simulation through our Economic Value calculation, where adjustments are made to accounting statements to more accurately reflect the economics of each driver.
In some cases where our initial assumptions generate a valuation substantially different from the current trading price, we attempt to be conservative and create a margin of safety by taking a very optimistic outlook for a Short position or a very pessimistic outlook for a Long position.
Since PINC has limited information regarding its historical performance, we offset this source of uncertainty by relying more heavily on peer data and by taking an exaggerated negative outlook. However, despite our cautious assumptions for the key drivers of our model, the company remains a clear Long (Figure 3).
Figure 3: Monte Carlo Simulation - Fair Value Distribution
(Table 7) In our view, the range assumption of 3 to 7% for Revenue Growth is very conservative given the mean for the peer set was 20.1% and the median was 9.4%. The overall weighted average Revenue Growth rate for the peer set was 8.4% (all statistics based on 10 years of data).
Table 7: Revenue Growth - Range Assumptions
(Table 8) Again, our estimates of Spread exhibit a fairly pessimistic view given the mean for the peer set was 3.0% and the median was 2.5%. The overall weighted average Spread for the peer set was 2.8% (all statistics based on 10 years of data). We assumed that the Spread for the company would decay from its current rate of 27.1% to a perpetuity value ranging from 0 to 3%.
Table 8: Spread - Range Assumptions
Our range assumption for NOPAT Margin is also pessimistic given PINC's most recent performance of 20.9% (Table 9). We anticipated that NOPAT Margin would decay between 8.8 to 11.6%.
Table 9: NOPAT Margin - Range Assumptions
Our range assumption for Capital Turns is again lower than recent performance of 1.71x (Table 10). We chose a range of 0.97 to 1.00x.
Table 10: Capital Turns - Range Assumptions
PINC remains a Long despite an exaggerated pessimistic outlook. This outlook helped us to address possible risk factors, such as the company's corporate structure and short tenure as a publicly traded company. We gain further confidence in our Long position when we compare the company's competitive position to one of its peers. Observing two key strategic forces, namely the industry's market economics (average Industry Spreads) and the company's competitive position (company Spread minus Market Economics), the analysis concludes the following (Figure 4):
- Although Market economics has worsened, PINC's competitive position signals a strong economic moat.
- In contrast, Quest Diagnostics Inc. has a weaker competitive position despite being a larger player.
Figure 4: Market Economics versus Competitive Position
Lastly, when we look at other valuation methods, PINC clearly stands out as undervalued (Figure 5). By example, based on S&P Capital IQ calculations, the company is trading at an absurdly low 2.70x TEV/LTM EBITDA multiple. In contrast, even though PINC grew Revenue at 5.3% with a positive Spread of 27.1%, one of its closest peers, DGX, decreased Revenue by -3.2% and generated a negative Spread of -1.1%, yet trades at a TEV/LTM EBITDA multiple of 8.1x.
Figure 5: Valuation Methods
As a final note, PINC generates strong cash flow and has approximately $233 million in cash (as of December 31st, 2013 Balance Sheet), giving it the financial flexibility to either grow extensively through profitable acquisitions or return cash back to shareholders. Either of these scenarios provides additional upside not accounted for in our very conservative outlook. Consequently, investors have a rare opportunity to get in early before the market prices in the company's strong economic position.