Investors have celebrated the growth story of Pro Medicus, shares in the stock have surged from $2 to $23 in the past five years. The company appears expensive, with a one-year forward price-to-earnings ratio of about 100 times. However, valuation is one of the five criteria that all stocks must clear before making into the portfolio at Aberdeen Standard Investments. The stock is a holding in their small-cap strategy, which raises the question, 'where is the value?'

In this video, Michelle Lopez, Aberdeen’s Head of Australian Equities applies there five selection criteria to this high-quality growth stocks and highlights the new opportunities that are not currently reflected in the price.

Click on the player below to access the video or read an edited transcript below.


Q. Can you share a company that passed your five-step selection process

Michelle Lopez:

Pro Medicus, I'm not sure if you're familiar with the business. t's a software imaging company and they provide software for radiologists and hospitals to stream the images onto their devices of tests and graphical representation.

Pro Medicus is a SaaS business, software as a service, and they are predominantly in North America, 75% of their revenues are there. The other 25% are here in Australia. And the other five is in Europe. If you think about the industry of healthcare in the US, they've recently just gone onto the medical record, electronic medical record, which means we're at the start of an upgrade capex cycle. And we're moving from legacy systems to best-in-breed capabilities that can plug and play, and Pro Medicus fits into that.

So for me, there's a very clear runway here for a business like that. If you look at radiology, which is the vertical that they're currently penetrating, it's the ripest for disruption with AI. So Pro Medicus have developed an AI algorithm to go into that place. So that's the industry.

Then you look at the business strategy. So Pro Medicus's strategy has been over the last few years, to go after that top-tier research hospital, that's tied to a university. What that means is a lot of the upcoming radiologists are being trained on this product. As they go out into the workforce, they'll be very familiar with it. So again, advocacy and word of mouth is really important. Talking to word of mouth. They have three sales reps globally, so you can see the benefit and the real value that these customers are having with the product, that you don't have a whole force of people out there doing the selling.

Then if I look at the management team, so the management team circa 50% of the business is still owned by the co-founders. One of the founders is the CEO, Sam Hupert. He is a doctor by trade, but also deeply, deeply passionate about this. Then we've got an incredible R&D team, based over in Berlin, that are very aligned to the success of the product.

And then the next step down, you look at the financials. they've got 30-odd million of cash on balance sheet. When you look at the revenue structure, not only is 95% of revenue recurring, but they're guaranteed in a contract. So, they've got minimum revenue guarantees, and then you've got very clear accounts with the business as well.

The final pillar, I suppose, is ESG that we mentioned, and this is an area that they're not perfect in, and we've identified them as a priority engagement for us. The important part is that they're willing to improve. If I think about data security, there's some easy wins that they can do there because they don't hold any of the data on their end-users and it's just a matter of publishing that. The other part is around governance structures. We're working closely with the company to, and I think that that's going to be an easy win for them.

The one thing is that everyone thinks, "Well, that's all great. Yes, it's a high-quality business, but it's expensive." And that's the other piece of our investment process that we are very focused about, the valuation of businesses and what we're willing to pay for them.

If I look at Pro Medicus and I think it's at 23, 24, $25, around that level, for me, what's priced in at these levels by the market is continued success in the radiology vertical. That's three to four new contracts per annum, around that $10 million mark, and continued penetration into that vertical.

What is not priced in is their AI capability and how they commercialise that is still unknown. So, you don't really want to factor too much of that in.

I don't think there's much in the price for other verticals. So, they're looking at oncology and ophthalmology as well. I don't think that's been reflected. Also, when you consider the execution and the re-pricing of contracts, many of these contracts are seven to eight years and many are coming off. And every single one, there's only been a few, have been re-contracted at significantly higher prices. Again, I question whether that's priced in. 

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Michelle and her team search for quality companies that are being underappreciated by the market. You can stay up to date with all of her latest content by hitting the follow button here.