Paragon Care (PGC) Big Boxes, Big Opportunity. Capitalising on the burgeoning healthcare sector. Price leadership through quality

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1 26 September 2014 Analyst John Hester Authorisation TS Lim Paragon Care (PGC) Big Boxes, Big Opportunity Recommendation Buy (Initiation) Price $0.33 Target (12 months) $0.38 (unchanged) Expected Return Capital growth 15.1% Dividend yield 4.9% Total expected return 20.0% Company Data & Ratios Enterprise value Market cap $20.0m $21.5m Issued capital 65.2m Free float 100% Avg. daily val. (52wk) $40, month price range $ $0.51 GICS sector Healthcare Equipment and Services Price Performance (1m) (3m) (12m) Price (A$) Absolute (%) Rel market (%) Capitalising on the burgeoning healthcare sector The healthcare thematic is now well understood my most investors. As country populations continue to become older and require more healthcare services, the proportion of GDP attributable to healthcare sector is likely to continue to grow. Paragon is a leading importer of capital equipment items and consumables for hospitals, aged care facilities and primary care providers. In addition, it manufactures and distributes its own branded range of stainless steel medical equipment, storage and shelving solutions and consumables. Price leadership through quality The Paragon brands are among the highest quality brands in the market and are priced accordingly. The quality of the products continues to resonate with large customers and it is this quality which drives repeat business despite a multitude of cheaper competitor product. Customers include a range of private hospitals, public hospitals, primary care and aged care providers. The business has completed 8 acquisitions since 2009 which have been funded via debt and backfilled with equity. Following completion of the recently announced acquisition of Scanmedics, the full year EBITDA run rate is now estimated at $4.0m. The business was acquired for 3.5x EV/EBITDA and is expected to be highly EPS accretive. The post acquisition balance sheet is modestly geared with interest cover greater than 6x in FY15. EPS growth in FY15 and FY16 is primarily due to the full year impact of recent acquisitions. We commence coverage with a BUY recommendation and price target of $0.38. In our view Paragon is well positioned to continue with EPS accretive bolt on acquisitions to further leverage its considerable distribution power. Absolute Price $0.6 $0.5 $0.4 $0.3 $0.2 $0.1 $0.0 Sep 12 SOURCE: IRESS Jan 13 PGC May 13 Sep Jan May Sep S&P 300 Rebased Earnings Forecast June Year End FY14 FY15e FY16e FY17e Revenues $'000 19,417 30,700 33,896 34,396 EBITDA $'000 2,151 3,684 4,068 4,128 NPAT (underlying) $000 1,485 2,603 2,999 3,277 NPAT (reported) $000 1,085 2,603 2,999 3,277 EPS underlying (cps) Norm EPS growth % 57% 45% 15% 9% PER (x) FCF yield (%) -11% 5% 13% 15% EV/EBITDA (x) Dividend (cps) Franking 100% 100% 100% 100% Yield % 4.0% 4.9% 5.7% 6.2% ROE % 8.2% 12.6% 13.3% 13.3% SOURCE: BELL POTTER SECURITIES ESTIMATES BELL POTTER SECURITIES LIMITED ACN AFSL DISCLAIMER AND DISCLOSURES THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 17 THAT FORM PART OF IT. Page 1

2 Contents Investment Case... 3 Market Overview... 5 Scanmedics Acquisition... 7 Financials... 9 Valuation Paragon Care Limited Page 2

3 Investment Case Paragon Care Limited (Paragon) has a broad range of products servicing the needs of hospitals, aged care providers and primary care. Its strategy is to become a one stop shop for its clients no matter which segment of the market is concerned. It has positioned itself as the only non-global provider of a full suite of medical products and niche consumables in Australia. Paragon has progressively acquired businesses to become a leading provider of capital equipment and niche consumables in the healthcare sector. Following the recent Scanmedics transaction it has now completed 8 acquisitions over recent years. Figure 1 - Overview of business segments Axis Health Iona Medical Volker Australia Scanmedics Acute & Extended Care Aged Care Aged Care & Home Ultrasound Stretchers Bedding & Mattresses High-end Beds for Acute care Newborn Care Medical Carts Furniture Furniture Asthetics Procedure Chairs Patient Slings Temperature Management Wheelchairs IV Systems GM Medical Acute & Aged Care Stainless Steel products LR Instruments Acute Care Surgical Products and Instruments Over 27,000 product lines Lifting Systems Wheelchairs Rapini Acute Care Storage Shelves Cool Room Shelves Service Carts Refrigeration Richards Medical Acute Care Surgical Instruments CSSD solutions Nursing accessories Stainless Steel Ware Axis Health, Iona, Volker Australia and Scanmedics represent major international brand names where Paragon has the exclusive distribution rights in Australia. Each of these are imported finished goods. The stainless steel business is represented by GM Medical. It manufactures a range of stainless steel medical equipment based in Victoria. The Rapini product range is storage and shelving solutions. Other proprietary product includes Liberty and L.R.I. These products are manufactured offshore for sale in Australia. GM Medical, Rapini, Liberty and LRI together represent the company s proprietary brands in the durable medical equipment space. LR Instruments and Richard Medical are the wholesaling and retail arms respectively of a range of consumables products for hospitals and aged care. Products sourced from Paragon s own product range constitute 45% of sales, with the remaining sales sourced from suppliers in North America and Europe via exclusive supplier agreements. Most of the items sold by Paragon are considered capital equipment purchases by its customers. This is a complicating factor in forecasting revenues as customers often buy in bulk purchases and timing is difficult to predict. Consequently, revenues can fluctuate significantly from one half year to the next. Page 3

4 Despite the volatility of revenues and earnings from period to period, the market for healthcare equipment and services has a long history of sustained growth. Hospital, aged care and primary care are the key customer segments for this business and each of those markets is expected to continue to grow revenues at faster than CPI growth rates. Gross margins in the product range vary. The margins are highest on surgical products and highly specialised equipment (LR Instruments, Richard Medical & Scanmedics) and tend to be lower on consumables and furniture particularly in the aged care segment. The majority of these supply agreements have several years to run, though the company does not disclose the timing of the expiries. Terms on these contracts are typically 3 years with two 3 year option, or 5 years with two 5 year options. Page 4

5 Market Overview Healthcare spending growing significantly faster than CPI Health Care expenditure in Australia in 2012 was over $140B. Strong growth has been seen over the past decade with health expenditure outpacing CPI, evidenced by expenditure per person rising from $4,276pp in to $6,230pp in This represents a CAGR of 3.8%. The key factors driving the increased expenditure on healthcare are an ageing population that is generally well funded, development of new therapies (including expensive cancer treatments), and increased utilisation of Australia s private health care system. Hospitals remain the largest area of health expenditure accounting for around 38% or $53B of health care expenditure in Primary Care which includes front-line health services such as GPs, Dental and other Health Practitioners is almost as large accounting for 36% or $50B of health expenditure. Paragon s extensive product range reaches various segments within Health Care including hospitals, aged care and primary care. Within these areas Paragon estimate the market size for capital equipment is $300m per annum ($250m of which is annual replacement spend and $50m is project specific greenfield and brownfield development fit outs), while the market for consumables and medical products is over $10b. Addressable market analysis We note the following segment split of revenues by markets and products: Figure 2 - Revenues by market segment Figure 3 - Revenue by product segment 2% 10% Public sector hospitals 8% 20% 60% Private hospitals and day surgery Aged care Primary care Other Many of the hospital sales are by tender, but equally significant business is generated through long stand customer relationships forged from years of good service and the supply of quality product. All three sectors of the market (hospitals, aged care and primary care) are highly disaggregated, hence there are many opportunities for winning new business. 1 AIHW Australia s Health 2014 Page 5

6 For example, in 2013 there were 1,338 hospitals with approximately 86,300 beds in Australia. These hospitals are either public (operated by State/Territory Governments) or private (operated by for-profit and not-for-profit providers). As at 30 June 2013, private hospitals comprised approximately one third of the market by beds, approximately 41% of total separations and approximately two thirds of elective surgeries were conducted in private hospitals. The residential aged care sector comprises 2,716 facilities operating approximately 186,000 places, more than double the size of the hospital sector. This number is forecast to increase to approximately 260,000 places by 2022, representing a CAGR of 3.8%. The sector is highly fragmented with approximately 63% of operators operating single facilities, 29% between two and six facilities and 8% operating seven or more facilities. Private operators represent approximately 38% of the market. In primary health care which encompasses General Practice and Allied Health, there are more than 20,000 registered GP s alone, the vast majority of which conduct operations in small, independent GP clinics. Due to its focus on the Victorian market, we estimate Paragon s market share across all segments is modest, certainly less than 10%. Paragon is consistently tendering for major hospital and aged care fit outs and long term supply agreements. Supply agreements are often 2-3 years in length. Some notable customers and agreements include Echuca Regional Health, Lifehouse at RPA, Sydney Adventist Healthcare, St. Vincent s Hospital, New Royal Children s Hospital Melbourne and Alfred Hospital Melbourne. The majority of customers are from the Eastern Seaboard which represents 80% of Paragon s market opportunity. The majority of revenues are generated in Victoria. History of acquisitions Since 2009 Paragon has acquired and integrated 8 healthcare businesses under the one platform, retaining the brand names of those businesses. This strategy began in 2008 following appointment of Mark Simari as Managing Director. Prior to 2008 Paragon was operating non related businesses in aged care. These were discontinued several years ago. 2 Subsequent acquisitions have seen the company build a strong suite of acute and aged care equipment products and consumables. Figure 4 - Acquisition timeline Period Acquisition Purchase price $m Jul-09 Axis Health 3.2 Jun-10 Volker and Iona 2.6 Nov-10 Rapini 2.8 Jul-11 GM Medical 1.9 Jan-14 LR Instruments Richards medical 5.3 Sep-14 Scanmedics The acquisition of LR Instruments and Richards Medical were completed over the same period. The two companies are related businesses and Paragon paid $5.3m for both businesses. The company estimates most acquisitions have been completed at less than 4.5x EV/EBITDA. 2 The aged care businesses generated substantial tax losses which Paragon continues to utilise. Page 6

7 Scanmedics Acquisition Further expansion of the product range Scanmedics is a NSW based business which distributes Neonatal, Aesthetics, Ultrasound and Temperature Management equipment to the health care sector. The Scanmedics acquisition further expands the product range available from Paragon. Paragon does not have competing products. The acquisition multiple is attractive at ~3.5x EV/EBITDA and less than the average multiple paid by Paragon for previous acquisitions. Figure 5 - Revenue and profitability metrics for Scanmedics $m FY14 Revenues 10.5 EBITDA 1.2 EBITDA margin 11% At the revenue line, Scanmedics is approximately half the size of the existing Paragon Care business. It generates a gross margin in line with the broader business. Expansion into NSW NSW is a largely untapped market for Paragon. Scanmedics is a NSW based business, hence, the acquisition will help drive growth in the largest healthcare market in the country. The sales network within Scanmedics will also provide a gateway for Paragon s existing product range. Complementing this is Paragon s established network in Victoria, so there are potential revenue synergies from the merger of these two businesses. Funding The transaction to acquire Paragon is an asset purchase, the detail of which are as follows: Figure 6 - Scanmedics - Acquisition metrics $m Purchase price 4.24 Comprising : Cash 3.60 Paragon scrip Sustainable EBITDA 1.2 Implied EBITDA multiple (x) 3.5 The cash component of the settlement includes a deferred component of ~$1m payable in September 2015 subject to meeting certain performance criteria related to revenues. The cash component of the acquisition - being $4.24m in total will be funded via existing debt facilities. The acquisition price includes working capital. As part of the settlement, the vendors of Scanmedics will accept ~1.96m PGC shares representing ~3% of the company. These shares are not subject to escrow. Earnings impact Page 7

8 The acquisition is forecast to add an additional $7.5m in revenue for FY15 (pro rata for 9 months of ownership) and $0.9m of EBITDA. Figure 3 Post Acquisition EBITDA ($m) 9 month pro forma Existing annualised EBITDA Run-Rate from 2H Scanmedics EBITDA Total Post Acquisiton EBITDA We estimate earnings per share impact in FY15 at ~0.7cps followed by 1.0c cps in FY16. These are highly material earnings impacts considering FY14 EPS was 2.0cps. FY15 FY16 Page 8

9 Financials The summary historical financial results are as follows: Figure 4 - Historical Profit & Loss Year end 30 June Jun-10 Jun-11 Jun-12 Jun-13 Jul-14 ($'000) Revenue 9, , , , ,416.9 Growth Large 73% -4% 8% 14% Gross profit 3, , , , ,047.1 Gross Profit Margin 39% 41% 44% 45% 47% EBITDA , , ,751.1 EBITDA margin 3.9% 8.5% 2.6% 8.7% 9.0% EBIT , , ,509.1 EBIT margin 3.4% 7.6% 1.0% 7.2% 7.8% Interest expense Pre-tax profit ,114.4 Income tax (expense)/benefit NPAT Normalised ,084.9 Following strong revenue growth through 2010 and 2011 driven by acquisitions, revenue decreased in 2012 due to challenging market conditions where demand for durable goods was subdued, brought on by government budgetary pressures. FY13 was a year of consolidation as the company amalgamated its various acquisitions. There were no acquisitions in that year. Long term demand growth for the product range is estimated at 3% to 5% annually. Price rises are normally annual and limited to low single digit increases. Contracted prices are normally subject to ratcheted price increases. Paragon has a total deferred tax asset of $1.2m (partially recognised on balance sheet and part unrecognised). The recognition of prior year tax losses has generated a net tax benefit in 4 of the last 5 years. Further tax losses are available and in the medium term we expect an effective tax rate of ~10%. Figure 5 - Focus on FY14 1H14 2H Revenue 8, , ,416.9 Growth -12% 43% 14% Gross Profit 3, , ,047.1 Gross Profit Margin 45.7% 47.3% 46.6% EBITDA , ,751.1 EBITDA Margin 4.6% 12.2% 9.0% EBITDA Growth -61.3% 163.5% 17.8% The first half/second half split of revenues and earnings in FY 14 demonstrates the seasonality of the business. It is significantly (but not overwhelmingly) exposed to capital expenditure patterns in both government and private buyers. Page 9

10 FY14 EBITDA included $400K in once off restructure costs. These related to redundancies following the recent acquisitions. Adjusting for this item, the EBITDA margin for the year was 11%. The product range is leveraged to large capital equipment purchasing patterns, capex budget allocations as well as the timing and completion of greenfield/brownfield developments within the sector. We expect the long term EBIDTA margin to stabilise at ~12% which is equal to the margin achieved in 2H14. As the company adds more product, we expect the margin should be consistent at this level. We do not expect significant cost synergies from the Scanmedics amalgamation as it is based in Sydney whereas Paragon is based in Melbourne. Figure 6 - Historical Balance Sheet Year end 30 June Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Cash 1,504 2,852 1,325 2,511 2,820 Receivables 2,791 3,639 2,819 3,089 5,071 Inventory 1,242 2,683 2,707 3,069 4,065 Payables -3,381-4,365-3,007-3,274-3,606 Net Working Capital 652 1,957 2,520 2,884 5,530 PPE Intangibles 5,187 7,351 8,383 8,378 13,601 Deferred tax Provisions and other Net assets ex debt 8,224 13,149 13,062 14,703 22,514 Funded by Debt 4,875 8,095 6,616 4,334 4,305 Shareholders equity 3,349 5,054 6,446 10,369 18,208 8,224 13,149 13,062 14,703 22,514 NTA (cps) Net Debt/Equity 101% 104% 82% 18% 8% Gearing (net debt/ net debt + equity) 50% 51% 45% 15% 8% Interest Cover (EBIT/interest) Net Debt/EBITDA Paragon had net debt at June 2014 of $1.5m. Current interest bearing debt is $850K. The liquidity remains solid with a Quick Ratio above 1:1. Working capital increased by $2.6m in FY14 with the majority of this being attributable to the January 2014 acquisition of LR Instruments and Richards Medical. We expect further growth in working capital as the business expands. Hospitals are notoriously slow payers, therefore, it is essential that the company negotiates similarly long terms from its suppliers. Debt levels have been elevated over the past few years, with gearing above 50% and net Debt/Equity also high. Paragon has used debt to fund acquisitions which it has then backfilled with equity. Intangibles relate to acquisition driven goodwill. Page 10

11 Figure 7 - Historical Cash Flow Metrics Year end 30 June Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 ($'000) Gross Cash Flow as % of EBITDA 57.6% 11.2% -58.3% 46.7% -98.4% Net Operating Cash Flow ,085.7 as % of NPAT 159.2% 17.1% 95.7% 98.1% % Business Acquisitions -3, , , ,539.7 Capital Expenditure Free Cash Flow ,277.3 Free Cash Flow (cps) Cash flow from operations in FY14 was negative due to an increase in working capital requirements associated with recent acquisitions. Cash flow conversion measured as gross cash flow as a % of EBITDA has been historically weak. However, with numerous acquisitions bedding down, we expect this cash flow conversion to improve in the coming years. Historically free cash flow has often been negative due to capital expenditure and business acquisitions. Again, free cash flow is forecast to improve significantly following a string of acquisitions, providing cash to pursue growth or any further business acquisitions. History of capital raisings Paragon has undertaken several capital raisings in recent years for the purposes of funding acquisitions, funding working capital expansion and to pay down or retire bank debt. Figure 8 History of Capital Raisings Year Description Amount Raised $m Issue price 2009 Placement 2.4 $ Convertible Notes Issue 3.0 Jul-11 Placement 0.1 $ 0.40 Jun-12 Exercise of options 1.4 $ 0.20 May-13 Placement 1.3 $ 0.27 Jun-13 Share purchase plan 0.9 $ 0.34 Jun-13 Placement 0.7 $ 0.27 Nov-13 Placement 4.0 $ 0.37 Dec-13 Placement 2.7 $ 0.37 Dec-13 Conversion of debt to equity 0.4 $ 0.37 Jan-14 Placement 0.8 $ Page 11

12 Forecast P&L Following the acquisitions of LR Instruments and Richard Medical in January 2014, we estimate the annualised run rate for EBITDA increased to ~$2.8m. This is based on the EBITDA of $1.4m in 2H14. For FY15 we expect Scanmedics to contribute $0.9m of EBITDA based on a full year run rate of EBITDA of $1.2m. Figure 9 - Forecast earnings 1H14 2H e 2016e Revenue - ex Scanmedics 8, , , , ,896.0 Revenue - Scanmedics , ,000.0 Total revenues 8, , , , ,896.0 Growth -12% 43% 14% 58% 5% Gross Profit 3, , , , ,422.7 Gross Profit Margin 45.7% 47.3% 46.6% 45.5% 45.5% EBITDA , , , ,067.5 EBITDA Margin 4.6% 12.2% 9.0% 12.0% 12.0% EBITDA Growth -61.3% 163.5% 17.8% 110.4% 10.4% Immediately following the acquisition, we expect net debt will rise to ~$5.3m. We expect interest cover will exceed 6.0x in FY15. Figure 10 - Post acquisition debt analysis Jun-14 Scanmedics Post Acquisition Bank debt Lease liabilities Non bank debt Gross debt Less: Cash at bank Net debt Non bank debt relates to a third party. Interest on this loan is payable at 9.5%. The loan is repayable in calendar Paragon recently negotiated a $10m facility with Westpac which may be used to fund the third party loan repayment. The third party loan is unsecured. Top shareholders Figure 11 Top Shareholders Top Shareholders at June 2014 Shares % Mr Murray J Turner 6.01m 9.2% Mr Joseph P Wolfson 4.26m 6.5% Mr Brett Cheong 2.83m 4.3% Mr Lionel S Richards 2.16m 3.3% Kim Eng Securities 2.03m 3.1% Mr & Mrs Peter J Diamond 2.00m 3.1% Mr Brent D Jones 1.56m 2.4% Mr Mark Simari 1.42m 2.2% Mr & Mrs Ivan Tanner 1.37m 2.1% Australian National University Investment Board 1.23m 1.9% Page 12

13 Management Mr. Mark Simari Managing Director: Appointed as Director in February Mr Simari is a key driving force behind the company having presided over all recent acquisitions. Mr Simari and Chairman Shane Tanner founded the company in its current form in Mr. Shane Tanner Non Executive Chairman: Appointed Also Chairman of Funtastic Limited (ASX: FUN) and Vision Eye Institute (ASX: VEI). Mr Tanner has more than 30 years experience in management at various healthcare companies including a period as the CFO at Mayne Health. Mr. Michael Newton Non Executive Director: Appointed Also Managing Director of Symex Limited Mr. Brett Chong Non Executive Director: Appointed Founder and former Managing Director of Axis health which Paragon acquired in FX management Paragon s earnings are exposed to movements in the value of the Australian dollar relative to the USD and EUR. The company pays for imported goods in foreign currency. The company manages its foreign currency exposure through a program of rolling forward currency contracts. It s policy is to hedge 100% of its short term exposure out to 6 months and up to 90% of the 12 month exposure based on the outlook. We estimate that a 5% movement in the value of the USD relative to the AUD would impact EBITDA by $0.4m. We estimate this would impact EPS by 0.4cps. Hedging is one of the instruments to manage foreign currency risk in the business. The overall objective is to maintain the gross margin at current levels. Other instruments available to achieve this aim include price increases to customers and negotiation of terms with suppliers. In some cases, suppliers are willing to invoice in AUD. Longer term devaluation of the Australian dollar would not affect earnings in the short term because of the hedging. Other items The company announced a maiden dividend of 1cps in FY13 followed by total dividend in respect of FY14 of 1.25cps representing a payout ratio of 62%. As the company is likely to continue to acquire businesses that achieve a high return on capital, it may preserve capital to fund those acquisitions rather than return excess capital to shareholders via dividends. The dividend is sustainable, however, the company may drop the payout ratio in future years depending in its capital requirements. The company undertook a 1 for 10 share consolidation in FY12. 3 Previously the company had traded under and different name (Citrifresh ASX: CTF) Page 13

14 Valuation Our target price is based on an assessment of sustainable earnings which we capitalised using an appropriate multiple. Figure 12 Earnings Multiple Valuation 2016 EV/EBITDA Earnings Multiple 7.5 Sustainable EBITDA 4,100 Enterprise Value 30,750 Post acquisition net debt - June 15-5,000 Equity Value 25,750 Shares on Issue (following acquistion of Scanmedics) 67,134 Value Per Share $ 0.38 There are several listed peers that form an appropriate base from which to value Paragon. API, Sigma and Lifehealthcare (LHC) are each involved in healthcare distribution. Of these LHC is the closest business match as it too has a significant exposure to the capital replacement cycle. These stocks trade at a discount to the broader ASX Health Care sector, which generally trades at a premium to the broader market. FY16 EV/EBITDA for the peer group averages 7.5x, while FY16 P/E ranges from 9x to 15x. Figure 13 Peer Comparison Company EV ($m) FY15 EV/EBITDA FY16 EV/EBITDA FY15 P/E FY16 P/E Peer Multiples API Sigma Pharmaceuticals Ltd Lifehealthcare Group Ltd Average SOURCE: THOMPSON REUTERS The target price of 38 cps represents a forecast FY16 price earnings ratio of 8.4x. The price earnings ratio is abnormally low because the company has tax losses which it may use in the years ahead. Consequently the effective tax rate is estimated at ~10%, resulting in a higher EPS than would normally be the case. As a cross check we also use a discounted Cash Flow Model which assumes a weighted Average Cost of Capital of 9.74%. This method results in a valuation of $0.42 per share. Page 14

15 Paragon Care Paragon Care is a role up of specialist medical distributors. It has exclusive distribution rights in Australia for leading brands of beds, mattresses stainless steel equipment, storage and shelving solutions, plus a range of consumable items and other capital equipment items. Approximately 45% of its revenues are derived from the sale of its proprietary designed and manufactured products. The company has completed numerous acquisitions since the current management team took control of the company in The market for medical distributors is highly disaggregated and consequently we expect there is a pipeline of future acquisition opportunities. Paragon Care has funded acquisitions with debt and back filled with equity. The company sells to a range of buyers including hospital (both public and private) as well as aged care and primary care providers. Hospitals are the largest market representing approximately 80% of revenues. Industry growth will continue to be driven by Australia s ageing population which may continue to demand high quality healthcare services. The products distributed by Paragon have a limited lifespan and will be subject to ongoing replacement. The hospital industry is highly regulated and accreditation is dependent upon maintaining minimal standards for cleanliness primarily for the purpose of infection control in the hospitals. Many of the products sold by Paragon are manufactured to satisfy these accreditation requirement and are therefore considered non-discretionary. The sector is well funded through a combination of Federal and State funding for hospitals, aged care services and Medicare for primary health care. The vast majority of the customer group are healthcare service providers as opposed to retail, therefore, self pay is a very low proportion of the business. Valuation We determine Enterprise Value by applying a multiple to the sustainable EBITDA. The estimation of the multiple is based on the market multiple of a peer group, plus our estimate of value for particular matters as they apply to Paragon Care. The cross check of value is a discounted cash flow model. Risk Areas The key risk areas are: Currency risk Paragon sources most of its product from offshore, either as imported finished goods or from contract manufacturers of its own proprietary designed products. The majority of product is invoiced in foreign currency being mainly USD & EUR. A significant devaluation of AUD would affect gross profit margin if the company were unable to offset the impact through either price rises, FX currency hedges or renegotiation of terms with suppliers. Regulatory reform the healthcare industry is highly regulated and is dependent upon government funding and private health insurance for the majority of its revenues. A significant adverse change in the funding mechanism for hospitals in particular is likely to impact ordering patterns of key customers. Page 15

16 Paragon Care as at 26 September 2014 Recommendation Buy Price $0.33 Target (12 months) $0.38 Paragon Care (PGC) 26 September 2014 Table 1 - Financial summary Profit & Loss (A$m) FY13 FY14 FY15e FY16e FY17e Profitability Ratios FY13 FY14 FY15e FY16e FY17e Year Ending June Year Ending June Total revenues * 17,096 19,417 30,700 33,896 34,396 EBITDA margin 8.7% 11.1% 12.0% 12.0% 12.0% Revenues growth 8.5% 13.6% 58.1% 10.4% 1.5% EBIT margin 7.2% 9.8% 11.2% 11.2% 11.2% EBITDA 1, , , , ,127.5 EBIT growth 707.0% 55.3% 79.9% 10.6% 1.5% Depreciation Valuation Ratios (A$m) Amortisation EBIT 1, , , , ,852.4 Reported EPS (cps) Normalised EPS (cps) Net interest (523) (395) (542) (464) (211) EPS growth (%) na 57% 45% 15% 9% Pre tax profit 706 1,514 2,892 3,333 3,641 PE(x) Tax expense 33.4 (30) (289) (333) (364) EV/EBITDA (x) NPAT- normalised 740 1,485 2,603 2,999 3,277 EV/EBIT (x) Net abnormal items Reported NPAT 740 1,085 2,603 2,999 3,277 NTA (cps) P/NTA (x) Cashflow (A$m) Book Value (cps) Gross cashflow 695 (1,723) 1,921 3,673 3,811 Price/Book (x) Net interest 31 (359) (542) (464) (211) Tax paid - (4) (155) (129) (261) DPS (cps) Operating cash flow 726-2,086 1,223 3,081 3,339 Payout ratio % 0% 64% 40% 40% 40% Maintenance capex (182) (192) (250) (250) (250) Dividend Yield % 3.2% 4.0% 4.9% 5.7% 6.2% Free cash flow 544-2, ,831 3,089 Franking % 100% 100% 100% 100% 100% Business acquistions (11) (3,540) (3,595) - - FCF yield % 4% -11% 5% 13% 15% Proceeds from issuance 2,975 6, Movement in borrowings (2,281) 335 2,640 (1,803) (1,890) Performance Ratios FY13 FY14 FY15e FY16e FY17e Dividends paid - (758) (839) (1,028) (1,200) ROA 0.0% 5.5% 7.6% 8.6% 9.3% Change in cash held 1, ROE 0.0% 8.2% 12.6% 13.3% 13.3% Cash at beginning of period 1,325 2,513 2,820 2,000 2,000 ROIC 0.0% 6.8% 9.4% 10.3% 10.4% Cash at year end 2,513 2,820 2,000 2,000 2,000 Net debt/equity 18% 8% 24% 14% 5% Balance Sheet (A$m) FY13 FY14 FY15e FY16e FY17e Net debt/assets 10% 6% 15% 9% 4% Cash 2,511 2,820 2,000 2,000 2,000 Gearing 15% 8% 19% 12% 5% Receivables 3,089 5,071 6,822 7,532 7,644 Net debt/ebitda (x) Inventory 3,069 4,065 6,268 6,581 6,910 Interest cover (x) Other current assets Equity accounted investments Interim results 1H13 2H13 1H14 2H14 1H15e Property, Plant and Equipment Intangible assets 8,378 13,601 17,841 17,841 17,841 Total revenues * 9,217 7,879 8,145 11,272 14,100 Deferred tax assets Revenues growth 9% 9% -12% 43% 73% Total assets 18,389 26,951 34,049 34,851 35,166 Gross profit 3,936 3,705 3,719 5,329 6,416 Gross profit margin 43% 47% 46% 47% 46% Trade payables 3,274 3,606 5,769 6,370 6,464 EBITDA ,779 1,692 Provision for income tax EBITDA margin 10% 7% 5% 16% 12% Deferred revenue Provisions NPAT- normalised , Debt - interest bearing debt 4,334 4,305 6,946 5,143 3,253 Total Liabilities 8,020 8,743 13,432 12,263 10,501 Net Assets 10,369 18,208 20,617 22,588 24,666 Share capital 15,040 22,809 23,454 23,454 23,454 Retained earnings (4,814) (4,487) (2,723) (752) 1,326 Reserves 143 (114) (114) (114) (114) Shareholders Equity 10,369 18,208 20,617 22,588 24,666 SOURCE: BELL POTTER SECURITIES ESTIMATES Page 16

17 Recommendation structure Buy: Expect >15% total return on a 12 month view. For stocks regarded as Speculative a return of >30% is expected. Research Team Staff Member TS Lim Industrials Sam Haddad John O Shea Title/Sector Head of Research Industrials Industrials Phone tslim shaddad joshea Hold: Expect total return between -5% Chris Savage Industrials csavage and 15% on a 12 month view Jonathan Snape Industrials jsnape Sell: Expect <-5% total return on a 12 month view Sam Byrnes Bryson Calwell John Hester Industrials Industrials Associate Healthcare sbyrnes bcalwell jhester Speculative Investments are either start-up enterprises with nil or only prospective operations or recently commenced operations with only forecast cash flows, or companies that have commenced operations or have been in operation for some time but have only forecast cash flows and/or a stressed balance sheet. Such investments may carry an Tanushree Jain Financials TS Lim Lafitani Sotiriou Resources Stuart Howe Fred Truong Quantitative Tim Piper Healthcare/Biotech Banks/Regionals Diversified Resources Resources Research Assistant tnjain tslim lsotiriou showe ftruong tpiper exceptionally high level of capital risk and volatility of returns. Bell Potter Securities Limited ACN Level 38, Aurora Place 88 Phillip Street, Sydney 2000 Telephone The following may affect your legal rights. Important Disclaimer: This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Bell Potter Securities Limited. In the USA and the UK this research is only for institutional investors. It is not for release, publication or distribution in whole or in part to any persons in the two specified countries. In Hong Kong this research is being distributed by Bell Potter Securities (HK) Limited which is licensed and regulated by the Securities and Futures Commission, Hong Kong. This is general investment advice only and does not constitute personal advice to any person. Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives ( relevant personal circumstances ), a Bell Potter Securities Limited investment adviser (or the financial services licensee, or the representative of such licensee, who has provided you with this report by arraignment with Bell Potter Securities Limited) should be made aware of your relevant personal circumstances and consulted before any investment decision is made on the basis of this document. While this document is based on information from sources which are considered reliable, Bell Potter Securities Limited has not verified independently the information contained in the document and Bell Potter Securities Limited and its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Bell Potter Securities Limited accept any responsibility for updating any advice, views opinions, or recommendations contained in this document or for correcting any error or omission which may become apparent after the document has been issued. Except insofar as liability under any statute cannot be excluded. Bell Potter Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this document or any other person. Disclosure of interest: Bell Potter Securities Limited, its employees, consultants and its associates within the meaning of Chapter 7 of the Corporations Law may receive commissions, underwriting and management fees from transactions involving securities referred to in this document (which its representatives may directly share) and may from time to time hold interests in the securities referred to in this document. ANALYST CERTIFICATION Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. Page 17