Why I think Medica can help me become an ISA millionaire

But the firm has grown fast and sports a multi-year record of balanced escalation in the financial figures. Indeed, revenue, earnings and cash flow have all been improving. But Covid-19 hit trading hard. However, the recovery is happening now. And I reckon Medica will resume its growth trajectory soon.

The company operates in the healthcare sector and describes itself as the UK market leader in teleradiology services. And teleradiology is the remote electronic transmission of radiological patient images. That means Medica provides outsourced interpretation and reporting of Magnetic Resonance Imaging (MRI), Computerised Tomography (CT) and Plain Film (X-ray) images.

It offers two primary services to hospital radiology departments, its NightHawk urgent-reporting service and its Elective routine cross-sectional reporting service. Through those divisions, Medica contracts with “the largest pool of consultant radiologists in the UK.” That sees the company performing remote access teleradiology across its customer base of more than 100 NHS Trusts, private hospital groups and diagnostic imaging companies in the UK.

The shares are up about 3% today, as I write. I reckon that’s down to the company’s statement in the report saying there’s been “significant improvement in reporting activity towards the end of H1 2020 continuing into H2 2020.”

Indeed, Medica is seeing a surging recovery in operations after a collapse in earnings because of the coronavirus crisis. Looking immediately ahead, the directors reckon the company is “well-positioned to support clients, [and] manage a backlog of elective procedures.”  

Interim dividend maintained

Today’s figures cover the six months to 30 June, a period that saw hospitals postpone many normal medical activities. Total revenue declined by almost 23% year-on-year, mainly due to a more than 42% fall in revenues from the Elective division. Overall adjusted operating profit plunged by 62%. But the directors reckon Medica’s cash position remained “strong” through the period “demonstrating the resilience of the business model.”  

Indeed, the firm’s confidence reflects in the decision to maintain the interim shareholder dividend. And City analysts are optimistic, predicting a 35% surge in earnings in 2021 that will exceed pre-Covid-19 levels. It seems growth is firmly on track.

Meanwhile, with the share price near 134p, the earnings multiple for 2021 is just below 16. And the well-covered dividend yields is an anticipated 1.85%. I think that’s an undemanding valuation given the robust-looking growth prospects. And a small net cash position underlines the strength of the balance sheet.

As part of a diversified portfolio, I think this share can help me become an ISA millionaire, so I’d buy it today.

But I think it’s pretty safe to believe that the healthcare and pharmaceutical sectors will continue to expand as the world’s population ages, emerging markets become wealthier.

I’ve increased my portfolio’s weighting to this sector over the last year and plan to maintain this exposure in 2020. In this article I’d like to take a look at three London-listed stocks I rate as top healthcare buys for the year ahead.

Hidden value

My first — and biggest — pick is FTSE 100 pharma group GlaxoSmithKline (LSE: GSK). This well-known company has for many years operated with a diverse product portfolio including consumer healthcare products and specialist medicines.

This structure attracted critics who said that the group lacked focus. Chief executive Emma Walmsley appears to share this view. Less than three years after taking charge in April 2017, she’s now masterminding a process that will see the company split itself into separate consumer and pharma companies over the next three years.

The GSK share price has responded well to these plans and climbed 19% last year, beating the FTSE 100. I feel optimistic about this stock too. In my experience, splitting a company into two smaller, more focused businesses often improves the performance of both units.

Even after last year’s gains, Glaxo still looks reasonably priced to me on less than 15 times earnings, with a 4.5% dividend yield. I remain a buyer.

A small-cap winner?

My next pick is small-cap firm Medica Group (LSE: MGP). This company provides outsourced radiology reporting for NHS hospitals. Essentially, Medica recruits qualified radiologists and provides them with hospital-grade workstations. They can then provide scan reports remotely, including out-of-hours.

According to the company, it provides more than 1.3m reports annually for more than 100 NHS Trusts. I think it’s fair to say that it’s a market leader — presumably the NHS couldn’t manage without this service.

It’s certainly a profitable, fast-growing business. Medica’s turnover has increased from £9.5m in 2013 to £39m in 2018. The firm’s operating profit margin has averaged 21% during this time and it’s largely debt-free. The shares rose by 30% last year and now trade on 17 times 2020 forecast earnings, but I think this is a fair price for a highly profitable, growing business.

Profit from an ageing population

In most developed countries, populations are ageing. Birth rates are lower and people are living longer. Demand for joint replacements seems likely to keep rising, which should help FTSE 100 firm Smith & Nephew (LSE: SN).

The Smith & Nephew share price suffered some turbulence last year when it emerged that newly-arrived chief executive Namal Nawana was to quit after 18 months due to a disagreement over what he should be paid.

However, a new CEO was appointed promptly and the firm’s trading performance remained solid, with sales expected to have risen by 4.3% in 2019. Analysts are projecting a modest increase in profit for 2019, with a bigger 8% increase predicted for 2020.

Shares in this firm rarely look cheap. But they’ve doubled since 2014 and I believe continued growth is likely. For long-term investors, I think it’s worth paying 22 times forecast earnings to own a slice of this business.

What’s more, many of the companies in the FTSE 100 today are constricted by their size. It’s easier for a tiny business to double its size — and your money — than for a big one.

With that in mind, here are two small-cap growth stocks that I believe could be much better investments than the FTSE 100 today. 

Earnings double 

With a market cap of £261m, Zotefoams (LSE: ZTF) flies under the radar of most investors. The company, which produces cellular material used in a range of industries including packaging, transport, medical and construction, has seen net profit nearly double over the past three years as sales have jumped 43%. 

Analysts had been expecting the company to report an increase in net profit of 38% for 2018, but it now looks as if the group is set to beat this projection. In a trading update published this morning, management said that “full-year revenues and profit before tax are now expected to be slightly ahead of consensus market expectations.” All of the business divisions reported growth in the first nine months of 2018 and it seems that the firm just can’t keep up with demand.

New production facilities are on track to open in the UK and US next year. In 2020, a new facility in Poland is set to open its doors too. Management’s expansion efforts indicate to me that Zotefoams is planning for a significant increase in demand for its products over the next few years, and now could be the time for investors to get on board

The stock is changing hands today at 30 times forward earnings, which is right at the top end of what I would consider acceptable for a growth stock. However, the recent update is enough to convince me that the shares are worth this high price. If profits go on to double again over the next three years, as they have in the last three, investors could be well rewarded.

Attractive margins 

Another small-cap that’s recently caught my eye is Medica (LSE: MGP). What I like about this health-tech business is its robust profit margins. For the past five years, the operating profit margin has averaged 21%. And profits have exploded since 2015. Earnings per share (EPS) jumped 157% in 2016, 42% in 2017 and are set to grow 37% for 2018. 

However, despite the explosive growth, it seems that the rest of the market has not woken up to the opportunity here. Shares in Medica are currently trading at a forward P/E of just 18.3, falling to 15.9 for 2019, which looks too cheap to me. 

Alongside the company’s unaudited half-year results, management confirmed that Medica is on track to hit City growth forecasts for the year, and strong cash generation will mean that by year-end, net debt will be close to zero from £2.5m at the halfway point. I reckon moving to a net cash position will result in acquisitions that could help accelerate EPS growth in the years ahead. There’s also the possibility of higher cash returns for investors. 

However, there are still a number of companies that could offer significant upside potential. Certainly it may be more difficult finding them in today’s bull market, but here are two stocks that could be worth a closer look given their outlooks and valuations.

Improving performance

Reporting on Monday was teleradiology specialist Medica Group (LSE: MGP). It was able to deliver an 18.2% revenue rise during the year, with its NightHawk out-of-hours reporting service delivering sales growth of 24.1%. There was also progress in its Routine Cross Sectional division, where revenue was up 19.4%, while Specialist services and Independent revenue was 18.1% higher than in the previous year.

During the year, the company was able to deliver increasingly complex services while also increasing the number of radiologists under contract by 20%. With demand for its services increasing, it continues to have a relatively positive outlook for the long run. So far in 2018, the company is trading in line with expectations, with double-digit revenue growth anticipated.

In the present year, Medica is expected to report an 11% rise in earnings, followed by further growth of 19% next year. The company trades on a price-to-earnings growth (PEG) ratio of just 0.9, which suggests that it offers good value for money. As such, and with demand for healthcare services set to increase over time due to changing demographics, the prospects for the business appear to be impressive.

Low valuation

Also operating within the health care and equipment services sector is NMC Health (LSE: NMC). The company has an excellent track record of growth with its bottom line increasing in every one of the last five years. During that time, earnings have risen by 25% per annum. This suggests that the business has a high and consistent growth rate that could continue over the medium term.

Looking ahead, NMC is expected to report a 43% rise in its bottom line in the current year, followed by growth of 23% next year. Despite such a high rate of growth, which could continue over the long run, the stock trades on a PEG ratio of just 1.2. This suggests that the company’s share price could generate high returns in future years.

At the same time, risks seem to be relatively low. The sector in which it operates is generally consistent and defensive, which means that it could be worthy of a premium valuation over time. As such, from a risk/reward perspective, NMC could be worth buying now for the long run – especially since demand for healthcare products and services is due to increase.

Profits soar

Over the years, the Hastings-based healthcare services firm has grown to become the UK’s leading independent provider of radiology reporting, delivering in excess of 1.3m reports a year to NHS hospitals, private hospital groups and diagnostic imaging businesses.

In its first ever interim results as a public company, the group revealed continued strong growth, delivering a 17% rise in revenues to £15.7m during the half year to June. Adjusted pre-tax profits soared by an even more impressive 42% to £3.8m, compared to £2.7m for the same period a year earlier.

Management responded with a proposed first interim dividend of 0.55p per share, payable on 27 October to shareholders registered on 29 September.

Cyber-attacks

It’s worth noting the highly-publicised cyber-attacks in May, which caused major disruption to NHS systems, did not affect Medica’s own systems and IT infrastructure. And the company was quick to work closely with affected clients to minimise patient impact and to ensure that it could respond to referrals as soon as these clients were back online.

Despite the strong results, Medica’s share price had slumped by almost 6% by mid-afternoon, and I believe this was down to the market’s elevated expectations. Trading on a 2017 price-to-earnings multiple of 31 suggests to me that the market was perhaps hoping for even more impressive figures than those announced this morning.

Nevertheless, I believe a strong brand and growing customer base leaves the group well positioned for further long-term growth.

A safer alternative?

There’s no doubt that small-cap firms like Medica have the potential to deliver huge shareholder gains over the long term, but investing in these types of businesses can also involve taking on significantly higher levels of risk than with their larger, more-established, counterparts.

For those totally averse to such risks, I believe FTSE 100-listed Shire plc (LSE: SHP) could provide a very suitable alternative. The Dublin-based speciality pharmaceuticals business may not be as well known as blue-chip peers GlaxoSmithKline and AstraZeneca, but at £35.5bn is one of the top pharmaceutical and biotechnology companies in the world, with a leading position in the treatment of rare diseases.

A rare opportunity

In recent years Shire has further expanded and diversified both its product portfolio and geographical reach, yet still remains strong in the attention deficit hyperactivity disorder (ADHD) market for which it is best known.

The shares are currently trading on a very attractive valuation at just 10 times forecast earnings for 2017, giving investors a rare opportunity to buy this quality business at a knockdown price.

Improving performance

Reporting on Wednesday was healthcare company Medica Group (LSE: MGP). It provides teleradiology services and reported that it has continued to perform well in the first half of the year. Fortunately, the cyber-attacks in May did not impact upon its own systems and IT infrastructure. Furthermore, the company was able to quickly work with affected clients to minimise the impact on patients.

Medica has said that its recruitment of radiologists has continued to be strong, and it expects its results for the full year to be in line with expectations. For the year, it is forecast to record a rise in earnings of 113%. This is expected to be followed with further growth of 22% next year, both of which could lead to improving investor sentiment over the medium term.

Despite its relatively impressive outlook, the company trades on a price-to-earnings growth (PEG) ratio of only 1.2. This suggests that upside potential is significant. Although the company is relatively small and operates in a niche area, it seems to have a sound strategy through which to deliver improving share price performance. Therefore, within a diversified portfolio it could be an enticing buy.

Balanced potential

Also offering a bright future for its investors is public relations and integrated healthcare communications specialist Huntsworth (LSE: HNT). As with Medica Group, it has impressive future growth potential. It is forecast to grow its bottom line by 28% in the current year, followed by additional growth of 10% next year. This comes after a period of disappointment for the business which saw its earnings fall by 58% over a three-year period. However, having returned to positive growth last year, it seems to be on track to deliver more growth in future years.

With Huntsworth trading on a PEG ratio of 1.2, it seems to offer growth at a reasonable price. Alongside its value and growth appeal, it is also becoming a realistic proposition for income investors.

For example, even after halving its dividend in 2014, the company continues to yield an inflation-beating 3%. This is despite the company paying out only 41% of profit as a dividend. This suggests that rapid dividend growth could lie ahead, and even that a rise in shareholder payouts could exceed the company’s earnings growth rate without hurting its reinvestment potential.

As with Medica Group, Huntsworth is a relatively small entity and may therefore come with higher risk than many stocks. However, with a mix of income, growth and value appeal, it could post high share price gains in the long run.