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A radio advertisement promoted an in vitro fertilisation (IVF) clinic’s patient support and ability to help people who cannot have babies naturally. The ad was cleverly worded: enough detail to give hope to potential patients but no pregnancy success rates.
IVF clinics must be careful how they promote success rates after the Australian Competition and Consumer Commission in 2016 sensibly targeted false and misleading advertising in the sector. Few things are crueller than taking advantage of those desperate for children.
The ad was a reminder of how IVF has become an intensely competitive market that is attracting new entrants. When medical-service providers advertise on FM radio stations, and new competitors disrupt the industry with lower fees, you know the industry is lucrative.
Demographic and social trends are tailwinds for IVF providers. People in developed countries are tending to marry and have children later in life compared to previous generations.  Inevitably, that lifts IVF demand as it becomes harder for women to conceive later in life. 
A favourable regulatory environment, where Medicare co-pays for unlimited IVF cycles for women of any age, is another driver of industry growth. That could change with the Medicare Benefits Schedule Review Taskforce reviewing Assisted Reproductive Technologies. Previous Federal Goverments to limit IVF funding, by age, have failed. 
The emergence of lower-cost, bulk billing IVF operators, such as Primary Health Care, could spark an industry price war. The potential for lower IVF frees, and the availability of the service in more locations, is expected spur demand from new patients and support IVF cycles.
The IVF industry’s favourable characteristics explains why private equity firms invested in the sector here and overseas. Quadrant Private Equity backed Virtus Health, Australia’s largest IVF provider, and exited its investment through Virtus’ 2013 Initial Public Offering (IPO).
The market could not get enough of Virtus when it listed. The $5.68 issued shares soared to almost $9 with a year of listing.  The shares now trade at $5.61 after earnings disappointments in the past few years, rising IVF competition and signs of slowing industry growth.
Chart 1: Virtus HealthSource: The Bull 
Virtus’ main rival, Monash IVF Group, followed with a $315 million IPO in June 2014. Monash’s $1.85 issued shares mostly traded below their offer price, soared to $2.46 in September 2016, then tumbled to $1.60 after delivering earnings below market expectation.
Chart 2: Monash IVF GroupSource: ASX 
For all the IVF hype, Virtus and Monash are back below their issue prices, years after listing. That is an opportunity for patient value investors. Newspapers this month speculated that a Chinese group could be a suitor for Monash. The takeover speculation boosted Monash stock by about 15 per cent. 
Monash looks undervalued, although not excessively so. Morningstar values it $1.80 a share, having recently reduced its fair value from $2 after disappointing earnings. Monash’s personnel risk – that is, the potential earnings damage from prominent IVF specialists leaving its network – is probably the biggest threat. Personnel risk is a key issue across the industry.
I prefer Virtus to Monash on valuation grounds. Virtus provides assisted reproductive services through a network of clinics and embryology laboratories; specialised diagnostics such as testing of semen, blood, urine and genetic factors; and day surgeries.
Virtus conducted 18,669 fresh IVF cycles and had 46 fertility clinics in FY17, according to its latest annual report. Its group revenue decreased 1.8 per cent to $256.5 million in FY17 in another challenging year for Australian and international fertility clinics. 
Virtus lost some market share to lower-cost operators in FY 17 and key IVF markets, such as New South Wales, were a little weaker on the previous year. That Virtus had a small fall in revenue shows it is well managed and able to adapt to slowing industry conditions.
Still, low-cost operators are making inroads on the East Coast and successfully targetting price-conscious consumers. But this threat looks to be factored into Virtus and Monash stock at the current price.
IVF cycles, although down on the past financial year, was slightly head of market expectation. Virtus’ volume growth might be constrained by the low-cost operators, but it has scope to lower costs as its network grows and economies of scale expand.
The market has priced in a period of disruption as new entrants take share in the IVF sector. None of that changes the medium-term outlook for solid industry growth, probably in line with economic growth, and a modest increase in IVF pricing over time as the market stabilises.
A consensus of five broking firms (too small to rely on) values Virtus at an average $6.18 – a 13 per cent premium to the current price. 
Virtus’ forecast Price Earnings (PE) multiple of 13.7 times FY18 (based on consensus analyst forecasts) is not excessive for a market-leading medical technology/services firm in a long-term growth industry. An expected yield of 5.2 per cent, is another attraction. 
As is the trend of people having baby later in life and needing IVF services. The fact that predators might be ready to pounce on IVF companies highlights the potential value for long-term investors at current prices. 

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• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at October 23, 2017