A Health Care Recession Buster

01/13/2009 12:01 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Roger Conrad, editor of Canadian Edge, says one Canadian health care company’s strategic acquisitions are paying off in high yields to investors.

Health care is always in demand, no matter what the economic climate. And as a dominant player in two key areas—laboratory testing and medical imaging—CML Healthcare’s (TSX: CLC-UN; OTC: CMHIF) position is far more secure than most.

CML has operated profitably under Canada’s national health care system since it was established in 1971 as a single medical laboratory in Ontario. Since then, CML has acquired 13 laboratory services businesses in Ontario and operates 124 clinics providing hematology, biochemistry, cytology, microbiology, histology, [and] prostate-specific antigen (PSA) and human papillomavirus (HPV) testing.

Third-quarter 2008 revenue zoomed up 50.9%, increasing cash flow 6.8% and distributable cash flow 18.8%, taking the payout ratio down to 84.3%. That’s right in line with last year’s figure and points to considerable payout safety.

Management continued to focus on acquisitions, further consolidating the medical imaging systems business in Canada. And it managed to win a solid increase from the government for certain price caps on services.

Absorbing new facilities caused third-quarter operating, general and administrative expenses to rise to 71.5% of revenue from last year’s 59.7%. That was partly a result of increased costs, but also due to medical imaging acquisitions that have lower margins than those on laboratory testing services. Judging from the pattern of prior acquisitions, however, those numbers should improve.

Acquisition-related debt increased interest expenses 37%, year-over-year, but net debt-to-total capitalization remains relatively modest at 32.6% at the end of the third quarter. Debt to cash flow climbed to 2.2x, up from 1.7x at the beginning of the year.

CML has no major debt maturities upcoming for several years. Also, management has a strong track record of generating cash flow and applying it to debt reduction, and banks continue to be willing lenders.

Dominion Bond Rating Service rates CML’s debt STA-2 (low), one of its very highest for any income trust. It reaffirmed [the rating] earlier this year following several acquisitions, while assuming debt leverage could go to 2.5x cash flow, rather than the current 2.2x.

CML units haven’t given up as much ground this year as many trusts. But it’s nonetheless more than a third cheaper for US investors than where it began the year. Coupled with a yield of more than 8%—which the company increased a healthy 3.5% in June—that makes CML a strong bargain for even risk-averse investors up to USD 13.CML closed Friday at $10.75.

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