Paragon Care : Bell Potter Report – FY18 Another Year of Growth for Paragon Care

14 September 2017

Analyst

John Hester 612 8224 2871

Authorisation

Tanushree Jain 612 8224 2849

Paragon Care (PGC )

FY18 Another Year of Growth

Recommendation Buy (unchanged) Price

$0.905

Target (12 months)

$1.02 (unchanged)

GICS Sector Healthcare Equipment and Services

Expected Return Capital growth 12.7% Dividend yield 3.8%

Total expected return 16.5%

Company Data & Ratios Enterprise value $167.8m Market cap $149.8m

Issued capital 165.5m

Free float 100% Avg. daily val. (52wk) $326,000 12 month price range $0.69 - $0.97

(1m)	(3m)	(12m)
Price (A$)	0.94	0.72	0.83
Absolute (%)	-4.26	25.87	8.43
Rel market (%)	-5.10	24.69	1.21

Price Performance

Organic Earnings Growth Continues to Build

Following a successful FY17 in which the company recorded 35% growth in underlying net profit after tax, the valuation metrics remain attractive and accordingly we maintain our Buy recommendation. In particular the strong second half result was pleasing and confirmed that earnings are now heavily skewed to the latter half of the year. 2H17 EBITDA of $10.1m exceed the first half by 51%. We estimate return on invested capital at 10.7% and growing.

This note addresses organic growth levels following a series of acquisitions. Paragon has completed 8 acquisitions for total consideration in excess of $76m since 1 July 2013. The average purchase multiple is approximately 5.0x trailing EBITDA. We analyse the cumulative revenue and EBITDA impact through to June 2017 to derive implied organic growth.

Over the three year period of the analysis, FY17 revenues and EBITDA are 8.8% and 15.5% greater than the cumulative total of acquisitions and existing business respectively. All material acquisitions have been under PGC control for almost two years during which time there has been significant amalgamation of activities and consolidation of back office and distribution resources. Over the course of the next three to five years we believe PGC will be better positioned to capitalise on revenue and growth opportunities as amalgamation work is complete. The focus should now be on expansion.

In FY18 and beyond we expect a recovery in revenues from Western Biomedical as the WA economy emerges from a recession. We also expect the first significant revenues from Midas - the cloud based software solution business for Diagnostic reporting. PGC is also experiencing strong growth in its Ophthalmic, Aged Care and Service & Maintenance businesses.

Maintain Buy Rating, PT$1.02

There are no changes to earnings forecasts. Price target is maintained at $1.02. The price target implies a PE ratio of 15.0x FY18 eps.

Absolute Price Earnings Forecast

$1.00

$0.80

$0.60

$0.40

$0.20

$0.00

Sep 15

Jan 16

May 16

Sep 16

Jan 17

June Year End	FY17	FY18e	FY19e	FY20e
Revenues $m	117.2	126.7	133.8	140.1
EBITDA $m	16.8	18.4	19.4	21.0
NPAT (underlying) $m	10.2	11.1	11.8	12.9
NPAT (reported) $m	10.2	11.1	11.8	12.9
EPS underlying (cps)	6.2	6.8	7.2	8.0
Norm EPS growth %	16%	10%	6%	10%
PER (x)	14.6	13.3	12.5	11.4
FCF yield (%)	7%	7%	8%	9%
EV/EBITDA (x)	10.0	9.1	8.7	8.0
Dividend (cps)	3.0	3.4	3.6	4.0
Franking	100%	100%	100%	100%
Yield %	3.3%	3.8%	4.0%	4.4%
ROE %	12.3%	12.4%	12.4%	12.7%

May 17

PGC S&P 300 Rebased

SOURCE: IRESS SOURCE: BELL POTTER SECURITIES ESTIMATES

BELL POTTER SECURITIES LIMITED ABN 250063907721

AFSL 243480

Page1

DISCLAIMER:

THIS REPORT MUST BE READ WITH THE DISCLAIMER ON PAGE 6 THAT FORMS PART OF IT.

Non Cyclical Earnings Growth

We summarise the acquisition history of Paragon Care since starting from 1 July 2013 as follows:

Figure 1 - Revenue and Earnings Growth FY13 - FY17

$m Revenues EBITDA Purchase Price FY13 - reported 17.1 1.5 Acquisitions Nov-13 LR Instruments 4.0 1.3 5.3 Richards Medical Sep-14 Scanmedics 10.0 1.2 4.3 Oct-15 Western Biomedical 33.2 4.3 29.2 Designs for Vision 31.8 4.0 25.6 Meditron 8.8 1.5 6.0 Jul-16 Midas (BPe) 0.1 - 2.0 Sep-16 Electromedical (Bpe) 2.7 0.8 3.9

Sum total 107.7 14.5 76.3 FY17 Actuals 117.2 16.8 Implied Growth 8.8% 15.5% Aug-17 Medtech 0.5 0.1 0.6 Bell Potter forecast for FY18 126.7 18.4 na Implied growth 8.1% 9.4%

SOURCE: BELL POTTER SECURITIES ESTIMATES

In order to keep the analysis simple, Figure 1 does not adjust for part year of ownership of the most recent acquisitions. Purchase price does not include earn out payments.

The company reported FY17 EBITDA of $17.1m relative to $16.8m noted above, the difference being our write back to the income statement of one off items.

Over the three year period of analysis, FY17 revenues and EBITDA are 8.8% and 15.5% above the cumulative total of acquisitions and existing business respectively.

FY17 was the first full year of ownership for the three business acquired in October 2015. Of these there were mixed results. Western Biomedical is based in Perth and accordingly we expect it has tracked sideways since acquisition due to tougher condition in the WA economy. Consequently it is likely that revenues synergies from cross sell opportunities are yet to emerge.

Meditron is a specialist provider of ultrasound equipment to Urology specialists. It is the smallest of the businesses acquired in October 2015 with a relatively small market by comparison. The business has a low volume of high value sales. Since acquisition cost synergies have been realised, however the focus now is on revenue synergies.

Designs For Vision is a specialist supplier of equipment and consumables for the Ophthalmic and Optometry markets. Its key customers include independent optometrists and specialist surgeon groups. The business has continued to experience strong growth since acquisition.

For completeness we provide the following waterfall charts to reconcile the movement from FY16 to FY17 revenues and EBITDA. These charts split out the part year revenues and earnings contributions from each of the recently acquired businesses. The part year earnings from acquisitions in FY17 represents approximately 3 to 4 months of contribution.

Figure 2 - FY17 Revenue Analysis

Figure 3 - FY17 EBITDA Analysis

Revenue $m

EBITDA $m

120	18
115	3.0	3.8	16
110	14
105	8.5	12	1.1
100	8.5	117.2	8

1.0 0.4 1.5

95

90

8593.4

80

10

6 12.5

4

2

0

16.8

SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES

Organic revenue growth in FY17 is estimated at 4.0% while organic EBITDA growth is a respectable 12%. The company did not provide an estimate of the organic growth vs acquired growth for FY17, nevertheless our estimate is not incongruous with the EBITDA margin improvement from 13.4% (FY16) to 14.3% in FY17.

OUTLOOK FOR FY18 - KEY ASSUMPTIONS IN THE FORECAST

• Average prices rises across the portfolio of approximately 3% in FY18. This implies underlying volume growth of ~5%;

• Stronger growth from Western Biomedical as the WA economy begins to emerge from recession;

• First significant revenue generation from Midas Systems (interpretive software for reporting on diagnostic imaging) and strong growth in the service and maintenance business. Midas is expected to generate at least $1m of revenues based on existing business in FY18; and

• Growth in aged care beds - PGC experienced some supply disruption in FY17 as it changed from an externally supplied aged care bed to its own locally designed bed that is manufactured by contractors. We understand the new model has been well received by aged care operators and are aimed at the premium price point in the market. We expect these to make a modest contribution in FY18. Approximately 12% of PGC's business is in aged care (including the beds).

PGC also has some exposure to the weaker US$ as it purchases some inventory in US$. If the current strength in the A$ is sustained, we expect a benefit of up to $0.5m in FY18 relative to FY17.

1H18 EBITDA has been adjusted to reflect expected seasonality in earnings. In FY17 60% of EBITDA came in the second half. We expect the seasonality will decrease in FY18 as more of the business (i.e. Midas and Service) revenues and earnings are more evenly distributed.

We expect the company will pay $9.6m in earn out payments in 1H18, hence despite good cash flow from operations, debt levels are expected to remain at around current levels in the medium term. By June 2018 we expect the Nebt debt/EBITDA ratio will be at ~1.3x with interest cover >10x. Total undrawn credit facilities at June 2017 were $31m.

The Board's stated maximum leverage ratio is 2.0x. Based on our forecast FY18 EBITDA and net debt at June 2018, we estimate PGC has available debt capacity of at least

~$13.4m before allowing for the incremental earnings impact of any acquisition. Expected cash dividend payment in FY18 is more than 2x covered by free cash flow.

Paragon Care

Paragon Care is a roll up of specialist medical distributors. It has exclusive distribution rights in Australia for leading brands of beds, mattresses stainless steel equipment, storage and shelving solutions, plus a range of consumable items and other capital equipment items.

In September 2015 the company diversified into medical consumables via the acquisition of Western Biomedical, Designs For Vision and Meditron. Following this transaction more than 70% of its revenues will be sourced from consumable sales rather than capital items.

PGC has now completed 10 acquisitions since 2009 for a total of ~$87.0m. The market for medical distributors remains disaggregated and consequently we expect there is a pipeline of future acquisition opportunities. Paragon Care has funded acquisitions with debt and equity.

The company sells to a range of buyers including hospital (both public and private) as well as aged care and primary care providers. Hospitals are the largest market representing approximately 80% of revenues.

Industry growth will continue to be driven by Australia's ageing population which may continue to demand high quality healthcare services. The products distributed by Paragon have a limited lifespan and will be subject to ongoing replacement.

The hospital industry is highly regulated and accreditation is dependent upon maintaining minimal standards for cleanliness - primarily for the purpose of infection control in the hospitals. Many of the products sold by Paragon are manufactured to satisfy these accreditation requirement and are therefore considered non-discretionary.

The sector is well funded through a combination of Federal and State funding for hospitals, aged care services and Medicare for primary health care. The vast majority of the customer group are healthcare service providers as opposed to retail.

VALUATION

We determine Enterprise Value by applying a multiple to the sustainable EBITDA. The estimation of the multiple is based on the market multiple of a peer group, plus our estimate of value for particular matters as they apply to Paragon Care.

The cross check of value is a discounted cash flow model.

RISK AREAS

The key risk areas are:

Currency risk - Paragon sources most of its product from offshore, either as imported finished goods or from contract manufacturers of its own proprietary designed products. The majority of product is invoiced in foreign currency being mainly USD & EUR. A significant devaluation of AUD would affect gross profit margin if the company were unable to offset the impact through either price rises, FX currency hedges or renegotiation of terms with suppliers. Regulatory reform - the healthcare industry is highly regulated and is dependent upon government funding and private health insurance for the majority of its revenues. A significant adverse change in the funding mechanism for hospitals in particular is likely to impact ordering patterns of key customers.