Buying turnaround stocks or “takeover targets” is not for the faint-hearted. A company might look “cheap” after falling 70% from its high, but it can be a value trap rather than good value. Investors anchor their expectations to the previous price peak and get burned.
They underestimate how tricky it is to turn around a troubled company. Or they overlook that the franchise has been badly damaged and that the company is different from the one a few years ago, making share-price comparisons less relevant.
But there are occasionally turnaround ideas with merit, if you know what to look for and are prepared to take higher risk. Finding stocks with falling debt, decent cash-flow growth and a reasonable Return on Equity (ROE) is key.
Takeover potential is another plus, but never the sole reason for buying. Always seek stocks that are good potential long-term investments, with or without takeover.
A good idea
Vision Eye Institute (VEI) is an example. It plunged from above $4.25 in late 2007 to 8 cents in mid-2011 and now trades at 66 cents. The ophthalmic services provider expanded too quickly, had too much debt, and almost went bust. Higher fees paid to doctors – a constant challenge in its industry – crunched profit margins.
Primary Health Care lifted its holding in Vision to 21.9% in July 2014 from 20%, according to data compiled by Morningstar. It owned 15.5% of Vision in December 2013. It has been creeping up its share register, and looks like the natural owner of it one day.
Primary Health Care is expanding more aggressively into specialist medical services, notably In Vitro Fertilisation. Ophthalmic services fit that strategy and Vision is trading slightly below fair value.
AMP has also bought more Vision shares this year, lifted its stake to 6.4%.
Vision’s problems peaked in FY10, when it lost $58 million. The net debt-to-equity ratio was 140%. By FY11, net debt-to-equity was a staggering 196%. Beneath this nightmare was an interesting business with a reasonable position in the ophthalmic market. Vision has 18 consulting clinics, eight-day surgeries, and seven refractive and laser eye surgery centres in Victoria, New South Wales and Queensland. It provides specialist cataract, refractive, glaucoma, cornea, medical and surgical retina and oculoplastics care, among other services.
On the right track
The results of Vision’s turnaround strategy are emerging. Revenue grew 3.3% to $110 million in FY14 and net profit after tax rose to $13.2 million from a $16.9 million loss a year earlier. Earnings per share rose to 7.9 cents from minus 11.5 cents in FY13.
A fully franked dividend of 1.25 cents a share for FY14 was important. Although small, the dividend signals that Vision’s management is becoming more optimistic about the outlook. It’s usually a good sign when turnaround companies start to pay dividends again.
The balance sheet has also been strengthened. Overall, bank debt was reduced by $9 million. Net bank debt (excluding cash) fell 32% to $27 million in FY14. Vision had $105 million in net bank debt in FY08 and $77 million in FY14. The net debt-to-equity ratio in FY14 was 34%, which should be considered low to moderate risk.
Vision’s big challenge is to stabilise doctor fees. Its net profit margin was crunched between FY06 and FY13, and doctors took an expanding share of the revenue. Its gross margin fell 1.8% in FY14, due to a larger medical staff and a continuing rebalance of profit share with doctors.
In its guidance for FY15, Vision said: “Doctor costs will continue to rise as we rebalance the clinic profit share with doctors in line with market conditions.” This rebalance should ease in the next year or two, as Vision pays market-share rates and a floor under how much profit doctors take from the eye clinics emerges. That should help Vision retain more doctors and potentially attract new ones to the business. It needs more bargaining power with key suppliers.
The upside
For all its recent problems, Vision has plenty of growth potential. A strengthened balance sheet provides capacity to buy other clinics and rebuild market share, without taking excessive risk. At this stage, it is an average-quality business with improving recent performance.
Longer term, the specialist medical-services industry should grow faster than the economy over the next five years, due to Australia’s ageing population. Business forecaster IBIS World predicts 4-5% growth in this industry over 2014-19 (the industry covers a range of services).
As more baby boomers leave the workforce, and as the population ages, demand for eye surgery should rise. It’s not hard to imagine cashed-up baby boomers increasingly looking to fix body parts, such as eyes, when they retire, and having laser eye surgery.
At 66 cents, Vision is on a trailing Price Earnings (PE) multiple of 8.4 times. A fall from the 52-week high of 82 cents during the latest share market correction has brought it into value territory. It’s not overly cheap, and suits investors, who are comfortable with higher-risk micro-cap stocks.
Contrarian investors with at least a three-year outlook could do worse than put Vision on their portfolio watchlists.
More will be known on Vision’s outlook when it provides earnings guidance at its Annual General Meeting on November 21. That could be the time to look closer at Vision’s unfolding turnaround.
• Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at October 8, 2014
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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