Paragon Care : Initiation Report Q4-FY17

CURRAN & CO May 2, 2017

Paragon Care (PGC) Healthcare Defragmented

Health Care Distributors

12-month rating BUY

12-m price target (A$) 1.35

Price (A$) 0.74

Upside 84%

Healthcare supplies and equipment distributor Paragon Care has demonstrated its capacity to acquire specialist healthcare businesses and integrate them into a one-stop-shop. With organic market growth and ample acquisition opportunities, we anticipate revenue growth of 47.1% p.a. and EBITDA growth of 54.7% p.a. in FY18. We initiate with a BUY recommendation a target price of $1.35 ps, based on a dividend discount model.

Industry growth rates to be exceeded via acquisitions

The healthcare supplies and equipment market is expected to track healthcare spending growth rates of +4.5% p.a. over the medium term. We expect Paragon will continue to exceed broader industry growth rates through acquisitions and anticipate the company will achieve its medium term $250m revenue target by FY19; an increase of $135m from the low end of FY17 guidance.

Market share can still be bought cheaply

The Healthcare supplies and equipment market is still highly fragmented, with hundreds of $1m-$10m turnover businesses, operating in the Australian industry. As many of these do not have competing product lines, Paragon is still able to acquire many

BBG: PGC AU

Trading data & key metrics

52-week range ($): 0.94 - 0.6

Market Cap ($m): 121

Shares on issue (M): 164.6

Avg daily volume (K): 361.6

Avg. daily volume ($m): 0.28

Directors:

Shane Tanner NEC

Mark Simari MD

Geoffrey Sam NED

Michael Newton NED

Brett Cheong ED

Substantials:

First Samuel 7.63% JMT Investment Group 6.14%

additional business with complimentary product ranges, at valuation multiples we anticipate will be within the 4-6x EBITDA range.

Synergies and scale to unlock better EBITDA margin

We expect OpEx growth to be more subdued than that of revenue, due to extraction of cost synergies from acquisitions and economies of scale. Thus, we consider it likely that Paragon will be able to reach its target EBITDA margin of 15% by FY19, up from a margin of 13.0% in FY16.

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Blue sky on Midas software platform

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Paragon's Midas, imaging interpretive reporting platform automates large parts of radiological reporting. Saving up to two hours of a Radiologist's time each day. While the software presents a compelling international business case, as it is early days, we have opted to not include potential Midas earnings in our current forecasts, but will do so as the opportunity develops further.

Analyst: Brendon Agius

e: [e-mail] t: 02 8188 9498

m: [phone]

Sales: Kevin Curran

e: [e-mail] t: 02 8188 9494

m: [phone]

Key financials - AUD$m
Year end Jun	2014A	2015A	2016A	2017F	2018F	2019F	2020F	2021F
Revenue	19.4	32.2	93.4	115.5	169.9	250.0	261.3	273.0
EBITDA	1.8	3.7	12.1	15.7	24.3	37.5	39.2	41.0
Underlying earnings	1.1	2.1	7.5	9.0	14.3	22.3	23.2	25.0
Reported Earnings	0.8	2.5	7.0	9.4	14.3	22.3	23.2	25.0
Underlying EPS (AUD¢ ps)	2.0	3.2	5.6	5.5	8.7	13.6	14.1	15.2
Underlying P/E	37.6	23.3	13.2	13.4	8.5	5.4	5.2	4.8
EV / EBITDA	68.6	34.6	11.5	9.8	7.2	5.4	4.5	3.9
DPS (A¢ ps)	1.5	1.4	1.6	2.5	0.0	0.0	2.5	3.0
Yield	2.0%	1.8%	2.2%	3.4%	0.0%	0.0%	3.4%	4.1%
Gearing (ND/ND+E)	7.5%	29.2%	20.7%	28.5%	36.5%	40.9%	28.2%	20.1%	| 1

Source: Company accounts, Curran & Co estimates. AUD$m unless otherwise stated.

Please see the last page of this report for important disclosures.

Industry Overview

Paragon Care is a distributor within the medical supplies and equipment industries, which entails the sale of both consumables (i.e. needles and syringes) and durables (i.e. dialysis and ultrasound equipment) to healthcare providers. These industries make up a component of overall Healthcare spending, which was approximately $161.6bn in Australia during FY15; accounting for 10% of the national GDP.

Figure 1 - Australian Healthcare expenditure by type FY15

3% 6% Public hospitals

Public Hospitals were 30% of AUS Healthcare spend in FY15

7%

10%

35%

30%

9%

Private hospitals

Primary health care Referred medical services Other services

Research

Capital expenditure

Source: AIHW Health Expenditure Database

Like much of the developed world, Australia and New Zealand's populations are aging, which is progressively increasing the demand for healthcare over the longer term. As a result, the Australian Government is forecasting its expenditure on hospitals to increase from $15bn in FY16 to 37.8bn by FY24, implying an average growth rate of 10.5% p.a.

Figure 2 - Forecast Federal Expenditure on Hospitals

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37.8

34.4

Federal expenditure on Hospitals anticipated to grow at 10.5% p.a.

$AUD Billions

30

20 1718.8

10

20.823.1

25.6

28.3

31.2

0

FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24

Source: National Commission of Audit

Currently, spending on medical consumables in Australia is estimated by Paragon to be greater than $10bn p.a. while spending on durables circa

$200m-$300m p.a. With the growth rates of these industries expected to track that of healthcare spending in general.

In Australia, these markets are comprised of a few major multinationals, such as Johnson & Johnson, General Electric, Medtronic and BD, with a large tail of several hundred domestic boutique suppliers.

There are five companies including Paragon that belong to the Healthcare Distributors Industry Group, that are listed on the ASX. The others being Lifehealthcare Group (LHC), Sigma Pharmaceuticals (SIP), Australian Pharmaceutical Industries (API) and Ebos Group (EBO).

PGC was an aged care service provider, but pivoted to distribution

Company History

Prior to becoming a healthcare product distributor, Paragon Care was a struggling aged care services provider. In response to underperformance, the board devised a new approach to the healthcare industry. Realising there was an opportunity to serve as a platform for healthcare providers, to purchase many of the industry specific goods they require.

For instance, industry fragmentation is such an issue, that some large hospitals are said to have over 30,000 suppliers listed in their procurement databases. Thus, a one-stop-shop which distributes quality products, in highly reliable and streamlined manner, is compelling to healthcare providers, as it can greatly reduce administrative burden.

Table 1 - Paragon's Acquisitions (FY10 - FY17)

Acquistions	Date	Purchase Price
AxisHealth	July 2009	$3,200,000
Iona & Volker	June 2010	$2,600,000
Rapini	December 2010	$2,750,000
GM Medical	July 2011	$1,850,000
LR Instruments & Richards Medical	November 2013	$5,300,000
Scanmedics	September 2014	$4,250,000
Western Biomedical	August 2015	$28,900,000
Designs for Vision	August 2015	$25,500,000
MediTron	August 2015	$6,000,000
Midas Software Solutions	July 2016	$2,000,000
Electro Medical Group	September 2016	$3,900,000
Total	$86,250,000

PGC is comprised of 13 acquisitions

Source: Paragon Care

Paragon began its entry into distribution with the purchase of AxisHeath in July 2009 and then continued to acquire other distributors to expand both its product and customer base. As of today, Paragon is comprised of the 13 acquisitions it has made since 2009, with its aged care assets disposed of in August 2011.

The acquisitions made in August 2015, were particularly transformative, giving the company an Australia wide sales footprint and resulted in revenue increasing by 190% between FY15 and FY16.

Figure 3 - Paragon Care's EPS FY12 - FY16

EPS growth was 48.8%

p.a. between FY13 and FY16

Earnings per Share

6c 5c 4c 3c 2c 1c 0c

-1c

5.6c

3.2c

1.7c 2c

-0.2c

FY12 FY13 FY14 FY15 FY16

Source: Paragon Care

Testament to the effectiveness of Paragon's M&A strategy has been its EPS accretion, with EPS growth at an average of 48.8% p.a. between FY13 and FY16. This is despite the weighted number of shares increasing by 212% over the same time frame, due to equity raises and some acquisition consideration being paid in scrip.

Company Today

Headquartered in Scoresby, Victoria, Paragon Care is the distributor of over 49,000 healthcare products, ranging from hospital beds to urology ultrasound machines, with the company representing all 455 brands exclusively in Australia and New Zealand.

Having grown rapidly to its current size via 13 acquisitions. Paragon's state-of-the-art Enterprise Resource Planning software and approach to aligning its personnel, have been key to Paragon's success in extracting value add from its numerous acquisitions.

Figure 4 - Portion of Sales by customer type

64% of revenue comes from public hospitals

10%

16%

10%

64%

Acute Care (Public) Acute Care (Private) Primary Care

Aged Care

Source: Paragon Care

The bulk of paragon's revenues come from public hospitals, with the company counting every public hospital in Australia as a customer. Private hospitals, aged care facilities and primary care providers, such as general practitioners, make up a minority of revenue, but provide Paragon with potential to grow its market share.

Roughly 70% of Paragon's revenue come from the sale of consumables, with the other 30% comprised of durables. A third category, added via the Midas acquisition in July 2016, is Software. While insignificant from a sales perspective today, it is a worldwide opportunity, that has the potential to become a major source of earnings over the medium term.

Industry players that are of a similar size to Paragon are rare, with no companies in Australia competing against PGC in the bulk of its product ranges. For instance, Paragon's closest ASX comparable, Lifehealthcare Group (LHC) mainly competes against it in point of care ultrasound, which is a small portion of sales for both businesses.

Table 2 - Paragon Care (PGC) & Lifehealthcare Group (LHC)

PGC trades on a slight

Peer Comparison

Market Cap P/E FY16 RevGrowth

FY16 EBIT

Growth

premium to LHC

Paragon Care (PGC)

Lifehealthcare Group (LHC)

124.6m 13.7 189.8% 235.2%

92.5m 13.4 15.6% 1.5%

Source: Curran & Co Forecasts

While Lifehealthcare Group trades on slightly lower price to earnings, Paragon has been engaging in a much more aggressive M&A strategy, with management expressing their intent for this to continue over the medium term. As such, we consider Paragon Care's slight valuation premium to be more than justified due to its high growth trajectory.