Cano Health Q2 earnings: Valuations and profitability unfavorable to the investment debate

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Investment Summary

Although there are currently many selective opportunities in healthcare, this report shows that Cano Health, Inc. (NYSE: CANO) shows a weak affinity with the type of equity premiums for which investors pay a premium in FY22. With various challenges to the growth of abundant earnings, it is not unreasonable to expect CANO’s lack of profitability to extend into FY24. It also has a negative tangible book value and therefore makes it increasingly difficult to assess the value of the business. With the culmination of the factors discussed here, we rate CANO neutral.

The pace of second quarter earnings picks up

Second-quarter revenue increased more than 100% year-over-year to $689 million, but declined sequentially from $704 million in the first quarter of FY22. The result was also below estimates consensus of approximately $23 million. The variance was attributed to a decrease in Medicare Advantage and Medicaid volumes in terms of revenue per member per month (“PMPM”). The downsides here come from the flow of new patients (who have fewer diagnoses by definition) and contract conversions to the risk-free label. Despite this, management predicts that PMPM should reach around $250 million this year.

Exhibit 1. Seasonality is evident in CANO’s operating model; however, top earnings growth continues to face headwinds for future growth

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Data: HB Insights, CANO SEC Filings

Revenue volumes were supported by a ~80% year-on-year spike in membership to nearly 282,000 at the end of Q2. In the second quarter of FY21, it had 155,000 members. Last quarter member mix was 44% Medicare Advantage, 14% Medicare Direct Contracting Entities (“DCEs”), 25% to Medicaid while the remainder was from Medicare Affordable Care Act (“ACA”). Understanding this breakdown is important, especially when thinking about projecting future cash flow and/or business revenue.

Meanwhile, the company saw a tailwind of 600 basis points to its medical cost ratio (“MCR”), with the MCR shrinking to 82.6% from 88.6% the previous year. Ex-DCE, then MCR was still around 200 basis points lower at 80.6%. The DCE segment is profitable for the company and remains to be watched, even though it is still in its infancy. This is mainly due to the fact that it is a small capitalization company, thus adding an effective multiplier to the margins compared to other business segments. Nevertheless, further reductions in the MCR are a bullish weight for the investment debate. CANO expects a full-year DCE MCR of 93%. He also expects the total MCR for FY22 to fall between 78 and 79%, as he predicts that the MCR “in the second half will be significantly lower than the total MCR in the first half…[t]this is primarily due to the normal seasonality of medical costs and cost recovery.”

The main challenges faced by CANO in the last quarter were related to expenses, in line with general market/macroeconomic trends. For example, its direct patient spend was about 7.6% of quarterly revenue, while it saw a headwind of 260 basis points on the SG&A line — and that excludes revenue-based compensation. shares of $31 million for the 6 months to June 30 (vs. $3.7 million year-on-year). Meanwhile, non-GAAP EBITDA was below expectations at $29 million and gave CANO an EBITDA margin of 4.3%. Operating margins were squeezed due to weakness in its DCE business. It now forecasts non-GAAP EBITDA of about $200 million for the full year, down from a previous forecast of $230 million to $240 million.

It also burned about $82 million in cash for operations, mostly to maintain adequate working capital and cash reserves. He also had an additional $120 million in undrawn facilities on his credit revolver and held $890 million in net debt. As the table below shows, without an increase in CFFO’s conversion cadence, the company risks burning through available cash. To offset that, CANO says it has made about $38 million in Medicare risk adjustment payments, and it expects that to be $130 million for the full year.

Exhibit 2. Cash trail estimated from Q2 FY22 cash burn, appears to be at risk unless it can increase revenue

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Data: HB Insights estimates

Line guidance upgrade with wider sector

Management expects Q2 Challenges to unravel at the end of FY22 and expects membership to be between 300,000 and 305,000. This is an upward revision of approximately 300 points baseline compared to previous forecasts. On this point, CANO estimates FY22 revenue to be between $2.85 billion and $2.9 billion, while MCR is expected to be around 79% at the high end, an increase of around 150 basis points. .

It also forecasts EBITDA in the range of $200 million, itself a substantial decrease from previous estimates of $230-240 million. Segmentally, he expects his medical centers to remain at a bolus of 184-189. Additionally, it calls for stock-based compensation of about $60 million, but capital expenditures of only $40-60 million.

By comparison, we estimate FY22 revenue at $2.86 billion, which expands to $3.7 billion for FY23, as shown in Appendix 4. We also see profitability at the net income level in FY23 with EPS of $0.04, after a loss of $0.05 in FY22. In this vein, according to our modeling (ceteris paribus), financial year 23 promises to be a year of inflection for the company.

Exhibit 3. CANO’s forward operating profit estimates – FY23 is shaping up to be a key year for the company

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Data: HB Insights estimates

Evaluation

The shares are trading at a premium at 3.47x book value and are priced at 1.02x forward sales. Looking at the tangible book value, however, and we see some differences, in that it has a negative tangible book value when adjusting for non-monetary assets like goodwill and intangibles. Let’s also not forget the $31 million in stock-based compensation for the first half of FY22. As shown in Appendix 5, the company’s intangible book value is more than $1.57 billion, or 73% of its total assets. Therefore, the company has a negative tangible book value of $732 million, which is in line with longer-term averages.

Exhibit 4. Intangible assets, goodwill, etc. represent more than 73% of CANO’s assets

It is therefore difficult to obtain a clear measure of the value of the company and to estimate whether we are paying a fair and reasonable price.

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Data: CANO 10-Q, Q2 FY2022

The stock is also rated below average in terms of valuation against Seeking Alpha’s quantitative factor ratings, as shown below. The trend has actually declined, with the alphabet scale dropping from a “C” to a “B” over the past quarter (“A” being best, “D” being worst). Valuations are therefore not attractive for the stock and we are not confident in estimating the company’s future cash flows given the myriad of factors affecting its results. Nonetheless, we believe there are more attractive value opportunities elsewhere.

Figure 5. The quantitative valuation factor ranking supports the idea that valuations are a hurdle to overcome

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Data: Seeking Alpha, NYSE: CANO

In short

Despite a period of growth in sales, challenges remain for CANO to recommend it as a buy. The investment debate is fraught with headwinds, and macroeconomic cross-currents weigh too, in terms of cost inflation and turnover.

Valuations are also not favorable to the investment case and, based on the culmination of the factors discussed in this report, we believe there are more attractive value opportunities to be found in the healthcare space. . Neutral rate.

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