No Images? Click here NEWSLETTER 23 August 2019 CORPORATISED DENTAL AND VET PRACTICE COMPANIES ANNUAL PERFORMANCE AND LESSONS FROM PRIVATELY OWNED PRACTICESThis newsletter contains commentary about both dental and veterinary companies and their weaknesses compared to privately owned and conducted practices. It is noted that while the dental profession has an oversupply of clinicians the issue in respect of the veterinary profession is a shortage of vets who are able to work full time. There are in fact many vets who are only prepared to work part time. It is apparent that corporate owners of both dental and veterinary practices are, in the main, struggling and their annual reports are characterised by varying degrees of corporate spin. The experience of corporatisation of professional practices is mixed with numerous failures and significant disappointments in the accounting, medical, dental and veterinary professions. Pacific Smiles Limited Pacific Smiles Limited has moved away from its former practice acquisition strategy toward developing new dental practices in growth areas. Its 2019 results show that while patient fees increased by 13.9% earned from an 11.3% increase in dental practice locations, its underlying net profit after tax (NPAT) was down by 3.5% and its dividend of 5.8 cents per share is down by 4.9%. NPAT was at $8.9 million or $100,000 per centre, or to look at it another way, $25,356 per dental chair. Patient fees were $187.4 million or $533,903 per dental chair. Figures can be interpreted in many ways but the reality is that fees per dental chair are far below what is achieved in many good privately owned practices. The change in direction represents recognition that the previous acquisition strategy was no longer viable on a significant scale. The current strategy of developing new centres will take quite a few more years to prove itself. Market share growth can be bought at significant cost but it is in our opinion a poor strategy compared to the much more controlled business model of the significantly smaller 1300 Smiles Limited which achieved NPAT of $7.8 million from $58.9 million of over the counter dental fees compared to Pacific Smiles NPAT of $8.9 million from over the counter fees of $187.4 million! Pacific Smiles is trading at a challenging price to earnings ratio of 25.0. Growth Corridors v. Established Suburbs Growth corridors are heavily populated by first home buyers with significant mortgages and little discretionary income. Practices located in growth corridors will mainly be drill and fill practices and it will be many years before they reach their real potential. The best practice locations tend to be the significant long established areas of middle suburbs. These are populated by long established families who have reduced their mortgage and watched their house grow in value and which are predominantly two income families with older children; and many of them are empty nesters. Many country practices are also good. Remember the parable of the Toorak cash poor versus the Clayton cash flow abundant. The people of Clayton typically had two incomes, low mortgages, drove ordinary cars and sent their kids to the local state school. If their dog hit by a vehicle and needed emergency surgery they were able to pay for it, and similarly if they needed advanced dental treatment. By contrast an element of the Toorak rich were in fact cash flow poor. They have huge mortgages, very high school fees for children at expensive private schools and payments on two expensive European vehicles. Although they may have had high incomes they also had huge demands on their cash flow and often could not afford a pet or were reluctant to pay for expensive dental treatment. Shallow Analysis? We are sceptical of the ability of stock market analysts to correctly interpret the financial performance of listed veterinary and dental companies. In our opinion they know too little about the business models of either veterinary or dental practices and are too easily led by the way in which annual reports of these companies are presented. They do not appear to understand the structural weaknesses in each profession and how they impact on corporatised practices. Compared to a range of listed companies these consolidated professional practice models represent greater risk than may be perceived by a desk top study of their figures. National Dental Care Limited Last year we reported that National Dental Care Limited had postponed its IPO and stock market listing because, as reported in the press, it had an accounting difficulty with a group of practices in Western Australia. Given the disastrous Smiles Inclusive Limited’s performance since listing last year and the widespread recognition of difficulties in corporatized professional practices it will now need to present a pristine set of financials to attract the support of professional investors. The reality is that a price earning ratio applicable to a listing five years ago or even one year ago may now need to be adjusted significantly to reflect investment markets. Statement from Managing Director of 1300 Smiles Dr Daryl Holmes “After all these years, about seventy per cent of dental services in Australia are still delivered by dentists in solo practices and very small partnerships. The business case for such structures keeps getting weaker as structure, regulatory and compliance requirements and increasing staff and facilities costs collide head on with the fact that the average solo dentist share of the market is flat or shrinking”. Our comment is that we view a quite different picture to Dr Holmes. We regularly benchmark the performance of dental practices from across Australia for whom we provide accounting services and we also value many practices of a variety of sizes and structures and which have a variety of accountants. The evidence we see is that there are many practices having a sole owner with one to three chairs or two owners with two to four chairs who remain profitable and whose DEBDIT percentage of gross fees remains remarkably steady. This is quite unlike the picture quoted by Dr Holmes. Indeed, the most profitable individual dentists we have seen over many years have been solo owners of one, two or three chair dental practices! We acknowledge that 1300 Smiles Limited stands out as the best of the dental corporates but with total dental over the counter fees of $58.9 million in 2019 it is a tiny element of dental practice in Australia. A number of other dental corporates are visibly struggling and the dental corporate portion of the market appears to be about eight to ten per cent with elements of health fund and public dentistry taking a proportion and of course larger practices than those indicated by Dr Holmes swell the private practice proportion of the market well beyond 70 per cent. The expectation that dental corporates would swallow up dentistry in Australia has not come to pass and given the increasing concerns of the share market is unlikely to come to pass. We note the history of accounting, dental, medical and veterinary related professional practice consolidations and the many failures. Investors are becoming increasingly aware of the high risk in these business models. Indeed, 1300 Smiles Limited’s relative success may be interpreted as an endorsement of its small size thus enabling its CEO to maintain a tight grip on its operations. Growth by acquisitions of other corporates can rapidly become the enemy of relative practice efficiency. Consolidation If consolidation of dental consolidators occurs ie. corporates buying out mini corporates, there will be increased management risk. Overwhelmingly, the best dental practices in Australia are conducted by active owner dentists. Corporatisation separates those better dentists from their practices after a relatively short time. No corporatized practise is likely to run as well as the best performed owner operated dental practices. Small is Better As the Americans say “nobody checks the oil in a rental car” nor do renters wash them. In our view, 1300 Smiles Limited’s relative success compared to other dental corporates is predicated on its small size and careful acquisition and operating process. We note that Maven is no longer buying practices in Australia, Ekera has tightened its acquisition criteria, Smiles Inclusive Limited has proved to be a disaster thus far, Pacific Smiles performance of the last year has disappointed and at least one other intending dental listing has been pulled back from IPO. Proportion of Well Run Private Practices Constant We predict that the proportion of well run privately owned dental practices in Australia will remain constant over the long term. At the bottom of dentistry a number of new practices opening will result in failure but enough will survive long term to replace any that have been purchased by the corporates, while a number of the corporates will leak patients back to privately run practices. The surplus of dentists is driving the urge to open. Those who cannot get traction quietly disappear. Most of those which survive for several years grow into good practices in the long term. Smiles Inclusive Limited Smiles Inclusive recently traded below 8 cents per share. We await its annual report with interest as it will represent its first full financial year of trading. Its tardiness in reporting is a sign of a struggling business. Its annual report hadn’t appeared on its ASX site by close of stock market trading on 30 August 2019 which was the closure point of the reporting cycle and is a bad sign. Apiam Animal Health 2019 Financial Year Results Apiam experienced a fall of 10.2% in net profit after tax to $4.0 million in challenging industry conditions despite overall revenue growth. Revenue increased by 4.8% driven by new acquisitions but segments of its business are adversely affected by drought. Despite net revenue growth in the 2019 financial year its second half revenues were impacted by “dry and challenging conditions”. Apiam has declared a dividend of 0.8 cents per share fully franked. Apiam has net assets of $61.3 million as at the 30th June 2019 but after allowing for intangibles (read goodwill on acquisitions) its net tangible assets are negative $3.9 million. This is fine provided that revenue and revenue margins remain strong. A combination of drought impact and the veterinary professions Australia wide staffing issues make this business very challenging. Poor Performance Apiam share price at close of trading on the 26th August 2019 was 44.5 cents significantly down over the past 12 months. The one year return to the 26th August 2019 is negative 19.09% made up of the combination of share price movement and dividends. National Veterinary Care Limited (NVL) Annual Results NVL continued its substantial expansion via acquisitions during the 2019 financial year purchasing 32 additional practices including a New Zealand group. At the 30th June 2019 it owned 98 veterinary clinics. The net profit after tax grew from $6.24 million to $8.04 million in line with its growth by acquisition strategy. It has declared a final dividend of 3.5 cents per share fully franked. Unlike Greencross, NVL has followed a strategy of having its clinics retain their local branding identity. Its real challenge is likely to be that of veterinary staffing as principal vet practice owners who sell to NVL pass their contractual earn out periods and move into retirement. A generation of practice owners who worked full-time will be replaced by veterinary staffing from a population of vets which is increasingly made up of those who wish to work part-time family friendly hours. This is an issue right across the veterinary profession. The full impact of the retirement of vendor vets who sold their practices to NVL are yet to be felt because of the relatively short period that the company has been in existence. We expect the impact to be substantial. Located Near Corporate Practices We note the experience of a large number of privately owned practices which have been located near a corporate practice who gain a steady stream of new clients as a result of the corporate practice not being able to satisfy their needs including having qualified veterinary staff available at times convenient to the pet owner. In some instances the need to restrict veterinary rosters due to staffing problems has meant that pet owners wishing to take their animal to the vet after they come home from work have found that a corporate practice has not been able to meet their need, and inevitably, they go elsewhere. The widespread experience of veterinary practice owner operators suggest to us that this trend will continue, and will continue to divert patients back to privately owned practices. Own a Practice near a Corporate Vet Practice The lesson for veterinarians is that if they are able to work full-time, then owning a practice located near corporate practices is a good business strategy. Whilst the corporates extol their advantages they are reticent when it comes to the issues of veterinary staffing. Ideally, a two vet team prepared to work hard, full-time to operate a practice and cover each other’s holiday absences will easily outperform nearby corporate practices. Success is based on client relationships not corporate speak. Non-owner operators simply don’t have the same incentive to build a business as do employees and turnover of staff in corporate practices, particularly those with many part-time employees frustrates clients and drives them away. Will Greencross Re-List – Will Vet Partners List? We wonder whether the other veterinary corporates looking to list or re-list their veterinary practice groups or to engineer trade sales can succeed? It defies logic that Vet Partners would not be having substantial veterinary staffing difficulties or that the private equity owners of Greencross are not having similar staffing difficulties. Many veterinary practices across Australia report that they regularly receive new clients who have been dissatisfied at a corporate practice. The difficulties are Australia wide. Much expertise has been lost as veterinarians who sold their practices to corporates have collected their respective bags of gold and retired to their beach houses, golf courses and mountain retreats. This has removed a huge amount of veterinary experience from practice in a relatively short time and the feminisation of the veterinary profession occurring from veterinary school classes of about 30 years ago has changed the makeup of the profession. While there many female vets who work long hours and have requisite experience there are obviously a large number of females and some males who are only available to work family friendly hours. As a result practices, particularly corporate practice groups have been restricting their hours which means that people who work normal business hours in other occupations and wish to take their pet to the vet in the early evening can be disappointed that the practice is closed or there is not a veterinarian on duty. Anecdotal evidence from many veterinary practice owners across Australia’s major cities indicate that owner operated veterinary practices which are prepared to offer traditional services, pick up lots of new clients who are former clients of nearby corporate practices. Do Corporate Analysts Understand the Pitfalls? The stockbrokers and investment bankers advising veterinary corporate groups on how to cash in their assets via trade sales or initial public office followed by stock market listings have a far more difficult problem than was the case ten or even five years ago. Any new product disclosure documents/prospectuses will be examined closely to determine whether the staffing risks now apparent in the veterinary profession are adequately disclosed. The level of price earning ratios on which veterinary corporates have traded have been out of step with reality. Disclosure My personal benchmark of a well managed Australian company is ARB Corporation Limited which over many years has performed soundly, produced arguably the best annual report of any Australian listed company, grown its business at a reliable rate and has done so consistently with nil or negligible net debt on its balance sheet. I own shares in ARB Corporation Limited in my family superannuation fund. I do not own shares in the dental or veterinary practice companies commented upon above. While utilising ARB’s consistency of performance over many years as a useful basis of comparison with listed or about to list dental and veterinary corporate businesses this advice is general in nature and individual professional advice should be taken before making investment decisions concerning any of the companies mentioned in this report. Best wishes, GRAHAM MIDDLETON Disclaimer The information contained herein is of a general nature and no specific action should be taken without individual advice. Speak with Synstrat staff as appropriate. Prepared by Synstrat Management Pty Ltd for clients of the Synstrat Group. Synstrat Management Pty Ltd is the holder of Australian Financial Services Licence No. 227169. ABN 57 006 295 325 The Synstrat Group provides Accounting, Financial Services, Business Advice, and Financial Advice. Prepared by Synstrat Management Pty Ltd for clients of Synstrat Group. 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