Medical Facilities Corporation - $DR.TO

3.6x EV/EBIT Buyback Champion

Lately, the tea leaves have been telling me that the future may not look like the past, the only thing that is certain, is uncertainty itself. Not exactly a comfortable time to be an investor, saver or spender for that matter…is there anybody out there right now salivating at their future prospects? Alas, everything is a risk, damned if you do, damned if you don’t, etcetera. So if I have to play in the market right now, how do I find a stock that I’d be comfortable buying and holding no matter what the market does?

It has to be cheap, so cheap, that I don’t really care if it ever gets discovered by the market, or multiples contract by 50%. It better be flowing cash, they aren’t just giving credit away anymore. Might as well make sure it’s self-funding, and it would be great to find a company who’s shares don’t get distributed like candy at Halloween. It would be pretty nice to find something that isn’t in terminal decline also…that would be great.

After diving into countless fruitless rabbit holes, dejected, I came across, Medical Facilities Corporation. Pretty boring, and perfect, exactly what I'm looking for. Well maybe not perfect, there is a little bit of hair on it, as you would expect on a stock trading at ~3.6x EV/EBIT, on the other hand, perhaps the hair priced in?

Cheap Price - check.

Not in terminal decline - check.

Profitable - check

No Share dilution - check check check.

In fact, they’re returning heaps of capital to shareholders.

Medical Facilities Corp (TSX: DR) (PNK: MFCSF) owns surgical medical facilities in the United States, in partnership with physicians, including approximately 4 Specialty Surgical Hospitals, and 7 ambulatory surgical centers, each focusing on limited, high volume, non-emergency surgeries and procedures. Historically, DR had created a lot of value for shareholders, rolling up surgical medical facilities, mostly paying out distributable cash flows as dividends.

The good times didn't last forever though, their last few acquisitions didn't go as well as planned, and once Covid struck, their payout ratios were no longer sustainable, topping 100%. Dividends were cut drastically, they went from paying out $0.09 monthly, to $0.07 quarterly. Covid hurt DR, lower surgical volumes resulted in lower revenues, inflationary pressures, particularly on medical staffing pushed expenses higher, all factor into a stock price hovering around $8.30 CAD with a market cap for ~$220m (CAD) and enterprise value of ~330m (CAD) today, down from a peak stock price of ~$22 CAD in 2016.

Though DR is down, it is not out. Revenues are back to $100m+ (USD) quarterly, surgical volumes were growing by 3%, operating income was around $67m (USD) ttm. Though we could expect operating income to be lower this year, as expenses are up 11% last quarter vs. volume increases of 3%. Despite this there is still meat on this bone.

Why does this opportunity exist?

Imagine the sentiment of a yield seeking investor base when their juicy dividends were stripped away from them.

More-so, the company has shifted strategies.

The Corporation plans to:

• suspend acquisitions;

• divest its non-core assets;

• pursue overhead cost reductions; and

• evaluate and implement strategies to return capital to its shareholders, including the commencement of a substantial issuer bid.

These corporate plans won't exactly sing their dividend hungry investor base, but they sure do sound pretty good to me.

Understandably, since all of the company's sales are in USD, their financials are reported in USD, however they report their cash available for distribution in CAD, share price, market cap, and enterprise value are also calculated in CAD. There will be some mistaken mixing of CAD and USD values when screening for valuation metrics, though still cheap on these measures, these screens may further obscure how cheap this stock truly is.

Capital Returns

~13% share-count reduction via multiple buybacks over the last 4 months alone.

* 10.38% in November retired Dutch Auction for $34m

* Further 2.7% share count reduction since then for $4.6m

* Share counts have been reduced ~20% over the last 3 years from 31m to ~25.5m.

Despite these capital returns to shareholders, price is down from ~$11 to ~$8 since the fall, this stock is not liked. You can't control what you can't control, at 3.6x EV/EBIT, the valuation is very undemanding, this investment could work out independent of market conditions. Having said that, there are some short term catalysts which could trigger a change in this negative price momentum.

Catalysts

DR hasn't reported since completing their recent material share buybacks. Databases and screens won't have been updated with new Share count. 2022Q4 results are scheduled to be announced on March 9, 2023.

Q4 is typically their strongest quarter of the year. We can already see from buybacks that they have returned more cash since their ‘22Q3 results were reported than their stated cash available for distribution of $3.8m, that's in addition to their $0.0805 dividend distribution.

Will we start to see progress on cost cutting, further easing of Covid related inflationary labor expense pressures, will profitability continue to normalize higher? It's too soon to tell, but these are plausible narratives at least which could begin to unfold in the coming quarters and could/should drive multiple expansion.

A recent and timely post on Value Investors Club by member AccruedInterest2246 whose recent write-up on CYH Community Health Systems debt discusses some of the labor expense pressures the industry has faced recently, the easing of those pressures, and the dislocation, whereby "the market is treating this temporary earnings impairment as permanent" 

Conclusion

In any case, with an EV/EBIT less than 4, downside should be very limited considering the stability and nature of the business, surgical volumes growing 3%, demographic and pent up demand post Covid bode well for the company. The reasonable valuation sets the hurdle quite low for a satisfactory return. Should we not see any change to profitability at all, collecting ~4% dividend yield, coupled with a shrinking share-count in the meantime is not a bad status quo at all.