RadNet Stock: Growth In Operating Earnings Off Little Incremental Capital (NASDAQ:RDNT)

Investment update

Since my June publication on RadNet, Inc. (NASDAQ:RDNT) reiterating it a buy the stock is +10% and we observed another set of strong quarterly numbers in its Q2 FY’24 earnings. Here I’ll run through my analysis of the quarter, updated modelling, and reinstated my next price objective to $72 per share, still eyeing long-term objectives of $95 per share in the base case.

Figure 1.

RDNT is clear evidence that the market pays very close attention to how businesses utilize capital by taking cash flows produced by their operations and redeploying them back into the business to produce more earnings power (defined here simply as more profits in dollar terms).

What this shows is how a company is creating economic value for its shareholders – not just the day-to-day or year two year machinations in the stock market. Actual economic value. The question is how a firm creates economic value – it does so by investing money and generating profits on those investments at higher rates of return than what investors can generally achieve elsewhere. Moreover, it is when a business can grow sales + operating earnings without the need to commit piles of cash to engender this growth.

Such is the case for RDNT, where post-tax earnings are +$0.81/share since Q1 FY’23, but the business runs on ~$5.33/share less operating capital it did back then. As such, you can see the ‘cross’ in operating earnings to invested capital in Figure 2, illustrating how the business is producing substantially higher earnings off the same level of investments as 2yrs ago.

Net-net, I reiterate RDNT a buy.

This is a name I know tremendously well, having covered it extensively here on Seeking Alpha. See previous analyses here:

Figure 2.

Q2 FY’24 earnings breakdown

RDNT put up $460mm of sales in Q2 FY ‘24 (+14% YoY). It pulled this to adjusted EBITDA of $72mm, +20% YoY. Growth was underscore by upsides in its imaging center and digital health segments.

Management revised FY 24 guidance to the upside and now expects revenues of $1.7 billion at the top end, pulling to operating earnings of $267mm. It looks to invest $145mm in capital expenditures, up from $135mm previously. My numbers call for the company to produce $1.7 billion in sales this year, and $121mm in post-tax earnings. I see this stretching up beyond $1.8 billion by FY’25 (see Appendix 1).

As the divisional highlights, my takeouts were the following:

• Imaging center revenues were $444mm, +13% YoY. Management said that utilization of its diagnostic imaging assets was higher, reflecting growth in ambulatory sites, and this is a trend I have been seeing through many healthcare service providers of late. What is happening is there is a shift away from hospital-based alternatives to niche operators such as RDNT. This is a tailwind in my opinion and it is a competitive advantage that will widen economic conditions tighten. People still look for value in their imaging services, and this is reflected by referring accounts as well. Critically, advanced imaging revenues were +150bps YoY reflecting this.

• The digital health business grew 36% over the year and put up $16mm in revenue. Earnings were +135% to $3mm for the quarter. Growth was underlined by the AI-powered breast cancer initiative, which saw growth of 137% over the year. Management also said the enhanced breast cancer diagnostic and mammography (“EBCD”) offering is almost complete. It reported that adoption rates are high, per the earnings call: “Adoption rates continue to rise and now exceed over 40% on the East Coast and are averaging close to 30% on the West Coast, where we have more recently implemented the program.”

• Overall procedure volumes increased 9.2% YoY, with imaging procedures exhibiting upsides across all categories, MRI, CT, and PET/CT respectively. MRI volumes expanded 16%, whilst the other two segments were up 15% and 20% YoY respectively. Meanwhile, same-center volume increases were +600bps, with same-center MRI, CT, and PET volumes up 12%, 10%, and 14% respectively (Figure 3). Overall, it performed 2.78mm procedures during the quarter.

Figure 3.

Year to date it has opened 5 new facilities, and has another 6 scheduled for opening by FY ‘24. It has 15 projects in development, many of which will be opened in FY’25. There is a 50-50 split between joint-venture/wholly-owned centers in this pipeline. It had 398 centers under its books by the end of Q2, and 37% of these are within health system partnerships giving them a structural competitive advantage in my view.

Valuation upsides remain firmly in view

RDNT is now a 3x EV/IC business after continuing the economics discussed earlier in this report. This has stretched up substantially from levels of ~1.7 X in FY 21. Management has plowed back $237mm back into the operating base of the business, and this has been valued at $2.9 billion in additional market value.

As such, every $1 management has put back to work in the company since FY’21 is valued at $12.55 in the market. This is tremendously attractive to the investment debate, as my investment thesis hinges on this company opening as many facilities as possible – in other words, reinvesting as much of its profits back into the business to expand its operating asset base and operating earnings. At a 3x multiple, this is highly attractive.

Figure 4.

Valuation insights

• Given the higher rewarded multiples, the business can compound at high rates with est. 33% reinvestment of NOPAT into core operations for growth, getting us to $72/share. On the downside, even with a sharp contraction in multiple to 2.5x (16%), we get to fair value by FY’26E.

Figure 5.

• The compounding ability at this level of valuation multiple is highly attractive. Under my estimates for FY’26E (see: Appendix 1) my view is there is a high propensity to compound our earnings power in owning this business over that time.
• A starter position of 1,000 RDNT shares gets us $1461 in earnings power today at a cost of $64,000 (Figure 6). My estimates project this to compound by 15% per year out to 2026, increasing cumulative earning power by 33.7% to $1.95 per share. This supports a buy rating – it outpaces our hurdle rate of 12% – where we assign a hypothetical investment that can reinvest 100% of its earnings at this 12% figure. My assumptions – which do not link the company to market value, only demonstrate earnings power – corroborate that RDNT can surpass this threshold. This supports a reiterated buy rating.

Figure 6.

Risks to thesis

Downside risks to the thesis include 1) sales growth less than 10%, as this reduces the valuation, 2) management slowing the pace of new store openings such that earnings do not compound at a similar rate, 3) new store openings not pulling their economic weight and underperforming the legacy base, and 4) the broader set of macroeconomic risks that must be factored in right now, including inflation, rates and geopolitical risks.

Investors must recognize these risks in full before proceeding any further.

In short

RDNT remains a buy in my view given the fundamental economics on display. Management continues to plow our funds back into new facilities, growing operating earnings with very little change in incremental capital employed. My view is the business is worth ~$72 a share today, with compounding ability up to $95 per share, my previously stated estimates of the intrinsic worth of this business. Net-net, reiterate buy.

Appendix 1.