We previously covered DocGo and rated it as a Buy. DocGo remains firm in its upward growth potential with strong technological advantage and recession-cushioned cash flow through long-term contracts. In addition, it demonstrated in Q3 both continued efficient cost control and the ability to grow market share without raising debt or issuing more shares, which are highly valuable in the current environment. Therefore, we raise the stock to Strong Buy.
DocGo experienced an onslaught after its Q3 earnings announcement. But we think it is more of a reflection of indiscriminate selling based on the headline numbers and a risk-off broader market than the company's fundamentals.
As reported in the headline, DCGO reported a $6.53 million revenue beat, and the missed EPS was reported as $0.03 instead of the average analyst expectation of $0.05. However, DCGO used $1.8 million for the remeasurement of warrant liability as a one-time expense. Excluding this one-time loss, net income would have been $4.3 million instead of $2.5 million. So its EPS would have been $0.052, a slight beat on expectation.
As we expected in the previous article, the end of Covid Testing did not make a material impact on DCGO's Q3 revenue. The Covid Testing contracts were folded into a community pharmacy program, along with other municipal contracts DCGO has, such as the one with New York City. Interestingly, it did mention the migration population's arrival in New York. The migrant health progress has since grown into a long-term contract for the company to provide services for asylum seekers within their shelters, although at a higher cost initially. As we learned recently, New York City will budget $600 million to provide shelter and schooling to migrants. The company's current engagement in this program will only expand in the near term. This is part of the strength we identified: Multi-year municipal contracts would provide a cushion against any economic slowdown.
To continue improving its operating efficiency, DCGO spent over $3 million this year and $1 million in Q3 alone to build its sophisticated proprietary technology with embedded artificial intelligence capability. This is one of the stand-out advantages we recognized before. In Q3, the company's transportation segment saw its gross margin increase to 23.2% compared to 7.1% a year ago. This improvement was due to its system being able to reduce overtime hours for field employees to increase volume and average trip prices with lower average hourly wages. Therefore, it was able to offset higher average fuel costs. This is a great example of how its AI-powered operating system can help mitigate costs through expansion. Although with limited data, from the chart below, we visualize it with a clustering analysis. The steep positive slope with a high correlation between the expenses for operation and the EBITDA highlights the strength of its technological platform. It is on the right track.
In the meantime, DCGO has also improved and maintained ample liquidity since a year ago, as its Quick Ratio is still around 3.5 times, more than double that a year ago. As of the end of Q3, its total cash and cash equivalence are essentially flat YoY, despite investing $35 million in acquiring licenses and new service offerings in new markets in the first nine months of 2022.
In Q3, DCGO actually reached almost its best quarterly Earnings from Operation (see chart below). If excluding the one-time loss of $1.8 million on the remeasure of warrant liabilities, the Net Income at $4.3 million in Q3 substantially improved over $0.8 million a year ago.
Another strength we did not particularly focus on previously but is highly relevant now is that DCGO has maintained a very low debt load. Although it continued expanding in key densely-populated urban areas and repurchased its warrants in Q3, it did not issue new debt nor new shares to raise the needed capital. Currently, its Debt To Equity ratio is standing at 0.08%. This makes a lot of difference in a rate-increase environment. When higher interest rates won't affect its EBITDA as much or bring about fewer constraints and expenses, the company can continue operating largely as it has been without exogenous shocks from lenders. For example, in Q3, it signed a new agreement with Sigma to provide urgent care and annual physical type services to its member population in New York and New Jersey. It launched a pilot with Dollar General(DG) in Tennessee to provide primary and urgent care services to DG's customers via a mobile health clinic parked in their store parking lots. This has promising potential growth with a massive national footprint and network. And out on the west coast, the company will enter a pilot program in Q3 '23 with Westpac in San Diego in MO patient monitoring or the RPM market, which is right in the valley of its strength to reduce hospital visits while providing at-home care to patients. All these pilot programs and opportunities would have a great chance to be executed without the hindrance of higher interest rate costs or debt burden. With everything else equal, this low-debt advantage ensures its growth momentum can be maintained. On top of that, it had brought back the outstanding warrants issued before the IPO, which was a one-time hit. Although the timing could have been improved, being free of outstanding warrants would help the company's equity growth in the long term. When the market punishes the weaker hands in the sell-off induced by a higher interest rate environment, this particular weakness doesn't exactly apply to DCGO. And if it continues maintaining its low debt burden, this advantage should be more apparent compared with other higher-indebted companies.
Now that higher interest rates will be here for longer, the merger and acquisition pace that DCGO has been taking in the past two years will probably slow down. The company will need to rely more on its organic growth for expansion in the near term, and some market penetration plans might be delayed. Although that won't change its growth trajectory, it might temporarily moderate the speed.
High inflation remains a risk for the company, with many of its costs, such as medical equipment and last-mile care delivery, being regular due to the scale of its operation and its personnel requiring ongoing professional training. Although the company has proven to excel at executing cost control, its Operating Expenses and Cost of Revenue are still at some of their highest levels. We do note that these numbers have actually come down against rising inflation since the beginning of this year. This is one of the areas we will continue to monitor and pay attention to.
In Q3, DCGO's Revenue rose to $104.3 million, a 21% increase YoY, although a slight 4.7% decline from Q2. Its Levered Free Cash Flow rose to $12.1 million, a 55% increase from Q2 and a 31.5% increase YoY. Its Current Ratio is at 3.54 times. Its Long-Term Debt is $1.5 million, the Debt-To-Equity ratio is at 0.08%. Its Total Liabilities were $85.1 million, a slight 9% increase from Q2, also a 9% increase YoY.
The company's Net Income was $3.2 million, an 8% decline YoY, with EBITDA at $7.2 million, doubling its level a year ago. Its Gross Margin is at 31.69%, Operating Margin at 4.02%, and Net Margin at 3.02%, roughly in line with the levels a year ago. It maintained a healthy balance sheet with similar earning momentum to a year ago.
With the current price in the low $7's, the market is essentially pricing in that DCGO will have zero growth in its free cash flow for the next five years through 2027. Or a 10% cliff-drop for 2023, and 0% for 2024, followed by only 3% growth every year from 2025 to 2027 in the cash flow we projected previously. We believe either scenario is unlikely as DCGO has a recession-proof cash flow cushion, as we alluded to earlier, continuously improving operating technological advantage, and market demand that is inelastic from the economic slowdown. People still seek a better way to attend to their medical needs. Consumers might be even more cost-sensitive to seek telehealth options as they are cheaper than in-person visits. As for urgent care demands, well, they are urgent.
The scenario of growth that drops off a cliff next year, or zero growth for the next five years, is unlikely for the company. We made minor adjustments to the Cost of equity and WACC since inflation has come down from 8.3% to 7.7%, and updated its Effective Tax rate to 14%. We see a bullish case of $14.46, where growth slows down slightly in 2023 but reverts back to its momentum and reaches a double-digit growth rate afterward. A bearish case of $9.75, similar to our previous estimate, assumes zero growth for 2023 but a more slowly increasing growth rate afterward until it reaches the top single-digit growth in a few years. And a base case of $12.28, where growth moderates but continues the expansion. Even the bearish case represents a 36.17% upside from, for example, an entry price of $7.16.
We see the current sell-off as the market looking to punish weaker hands. However, DCGO is not only still on a healthy growth trajectory, but it also isn't particularly vulnerable to the higher interest rate as it has maintained a low debt-to-equity ratio. We changed our rating on DCGO to a "Strong Buy" for a price below $7.5, given the current sell-off, and look for a double-digit upside in the medium term.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.