Canadian tech sector “never stronger”

PI Financial analyst Kris Thompson heralded the investment potential of a “never-stronger” Canadian technology sector. Looking back on the downward-sloping stock charts of the companies he covers since then, the analyst admits a tactical error but expresses continued faith in a tech turnaround.

Heralding a “never stronger” Canadian tech sector

“The first half of 2022 is a period that we hope to soon forget,” says the analyst. Mr. Thompson, based in Toronto and responsible for technology coverage at PI, says he had originally selected WELL Health Technologies Corp. (TSX—WELL) as a “top pick” (equivalent to a “best buy”) in the latter half of 2021 based on his investment thesis that health tech would “catch a bid again” after the COVID-19 pandemic rally and subsequent collapse.

“We were wrong,” he says, although he adds that, from January through June this year, the stock was “sadly” among the top-performing companies that PI Financial covers.

As of mid-July this year, the analyst noted, “The universe of health-tech stocks that we monitor is trading at about 40 per cent of the 52-week highs. Multiples now seem oversold in many cases.”

Mr. Thompson says, “The entire small-cap technology sector was decimated and there was nowhere to hide. Companies with strong balance sheets and break-even cash flow operating models outperformed growth stocks that rely on equity markets to finance organic growth and/or acquisitions.”

He argues, however, that health-related tech stocks are still primed for a comeback once the market turns toward growth-focused companies over “value” stocks. The analyst makes it clear he is not ready to throw in the towel on WELL Health, quipping, “The WELL is half-full, not half-empty.” He gives it a “buy” recommendation and continues to label it a “top pick” in addition.

WELL is a digital health company that operates primary and executive clinics in Canada and the U.S. It also operates a digital Electronic Medical Records (EMR) business, and provides digital health, billing and cybersecurity technology solutions.

Its CRH Medical subsidiary provides anesthesia services and a hemorrhoid banding product to clinics focusing on patients with gastrointestinal issues.

Elaborating, the analyst says, “Tech and health-care stocks remain under pressure but when the tide turns, WELL is a larger-cap, more-liquid stock that should attract investors seeking health-tech sub-sector exposure.”

He points out that the company is trading at about 38 per cent of its 52-week high, “all while executing to perfection and beating consensus every quarter since the first three months of 2020.”

“We continue to prefer WELL within our coverage universe for the same reasons as at the beginning of the year: a large addressable and defensive market, execution excellence, strong balance sheet and cash-flowing operations, and depressed valuation multiples.”

Mr. Thompson also praises the company’s disciplined adherence to its “rule of 30”, under which it targets combined organic revenue growth and earnings before interest, taxes, depreciation and amortization (EBITDA) of around 30 per cent. “With EBITDA in the 20 per cent range, organic growth of about 10 per cent is a blend of lower growth but steadier clinical services and higher-growth virtual services (contributing roughly three-quarters and one-quarter of revenue, respectively).” He describes the mix as a “diversified basket of complementary businesses.”

As for the strength of WELL’s balance sheet, the analyst notes that the company raised gross proceeds of $34.5 million by issuing equity in mid-May to use in opportunistic mergers and acquisitions while sector valuations remain depressed. He estimates that it holds about $69 million in cash, and can borrow up to US$160 million through CRH plus another $130 million from subsidiary MyHealth for acquisition purposes.

(WELL acquired MyHealth Partners Inc. in July 2021. The latter company owned and operated 48 locations in Ontario upon takeover. It offers primary care consultations in-person and remotely, as well as diagnostic services related to women’s health, cancer, bone and muscle health, and cardiology.)

Although it is maturing as a company, Mr. Thompson asserts, “WELL is still a hybrid growth story via mergers and acquisitions and some fast-growing segments including virtual services, with significant operating leverage once marketing spending is reduced.”

Exceeding expectations, on July 21, the company released preliminary 2022 second-quarter results which included revenue of more than $130 million and adjusted EBITDA of more than $23 million, although full figures were unavailable as of press time. By comparison, Mr. Thompson predicted $128 million in revenue and adjusted EBITDA of $23 million.

This is an edited version of an article that was originally published for subscribers in the August 19, 2022, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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