EQUITY RESEARCH GKCM RECOMMENDATION: BUY January 19, 2018

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1 Elite Diagnostic Limited Initial Public Offering (IPO) COMPANY BACKGROUND Elite Diagnostic Ltd ( Elite or the Company ) is a private company incorporated and domiciled in Jamaica under the Jamaican Companies Act, 2004, on February 28, The Company currently provides diagnostic imaging services such as computerized tomography ( CT ) and magnetic resonance imaging ( MRI ) scans, fluoroscopy, ultrasound and X-rays to patients at its Holborn Road and Old Hope Road offices. The Company s services are primarily utilized by individuals, medical practitioners and hospitals in Kingston, St. Andrew and surrounding Parishes. SUMMARY OF OFFER TERMS Issuer: Securities: Subscription Price: Elite Diagnostic Ltd Up to 70,680,000 Shares, inclusive of 18,000,000 Reserved Shares* $2.00 per Share payable in full on application Subscription Period: Opening Date: 9:00 A.M. January 24, 2018 Minimum Block Offer : Total Issued Shares: Total Authorized Share Capital: Brokers: Auditors: 1,000 Shares 353,400,000 Shares Unlimited Sagicor Investments Jamaica Ltd. & NCB Capital Markets Ltd Grant Thornton Ltd. SUMMARY STRENGTHS & WEAKNESSES Positives: Negatives: The Company will benefit from a 100% tax exemption for the first 5 years of listing on the junior stock exchange. Thereafter, the Company will be obligated to pay a partial tax charge for the following 5-years if it remains listed for 15-years. Steady growth in core revenues and capital base over the last four financial years to June The CAGR over that last four financial years was approximately 65.2% for revenues and 14.2% for shareholders equity. The Directors of the Company have indicated that the Company plans to pay a dividend of approximately 10% of after tax profits where such profits are available for distribution, subject to the Company s needs for reinvestment for growth and development. Delisting within 15 years will expose the Company to tax rates applicable during the concessionary period retroactively. Given the relatively small issue size, the stock is likely to be fairly illiquid which could adversely impact the ease with which an investor may acquire or dispose of units without materially influencing the trading price of the stock. The competitive landscape appears reasonably high with approximately six imaging diagnostic service providers identified in Kingston and Saint Andrew. Further, there is the possible threat of new entrants which could erode Elite s market share. The Company outlined that it intends to use the proceeds from the IPO to reduce its debt stock and expand its product range. This is likely to support net profit growth and improve cash position going forward. The solvency position of the Company has significantly improved over the last four years with the debt to equity position moving from 0.60X to 0.21X as at June Page 1 of 4

2 USE OF PROCEEDS The Company intends to use the net proceeds of the IPO to: 1) retire part of its debt obligations; 2) pay IPO costs; and 3) to provide working capital for the Company. The Company s long-term debt obligations are as follows: Financial Institution Amount Owing (J$) National Commercial Bank Jamaica Limited 30,985, National Commercial Bank Jamaica Limited 89,681, Sagicor Bank Jamaica Limited 5,066, General Electric Company 76,375, TOTAL 202,108, Key Ratios and Statistics Key Ratios & Statistics EPS (0.138) Book Value per share P/E Ratio (last 4 Qrts) N/A P/BV Ratio Net Margin -83.0% 0.4% 14.9% 16.8% Pre-tax Margin -83.0% 0.3% 12.0% 22.6% Current Ratio Debt-to-Equity Return on Average Equity N/A 0.3% 17.5% 21.9% FINANCIAL STATEMENT ANALYSIS Revenues The Company s revenues have consistently improved over the last four financial years to June 2017, moving from $58.3M in June 2014 to $263.1M in June 2017; a compound annual growth rate (CAGR) of 65.2% over the period. The growth in revenues emanated from increases in MRI Scans, the company s leading revenue earner, as well as CT Scans, Fluoroscopy, Ultrasounds and X-Rays. The Company s management team attributed growth in revenues to the use of state of the art equipment, continued improvement in patient care and customer service as well as the marketing of its services at medical conferences and through print and social media. Figure 2 shows the trend in revenues and the annual revenue growth over the last four financial years Profitability Elite s profitability has been improving over the last four financial years to June Net profits closed at $44.2M for the June 2017 financial year, a notable improvement over the reported net loss of $48.7M for the 2014 financial year. For the 2017 financial year, the increase in net profits was reported at 53% compared to the prior year and mainly resulted from growth in revenues amidst expansion in the company s operations. Figure 1 shows the trend in net profit/loss and net margin over the last four financial years to June financial year. $'000 Year Ended Jun-14 Jun-15 Jun-16 Jun-17 Revenue 58, , , ,096 Direct Cost (20,966) (45,797) (71,618) (87,407) Gross Profit 37,370 86, , ,689 Other Income Operating Expenses (41,785) (50,868) (61,467) (80,658) Depreciation and Amortisation (25,587) (25,723) (26,944) (28,023) Operating Profit (29,713) 10,268 33,608 67,181 Foreign gain/(loss) (8,696) (3) (88) 415 Finance Costs (10,274) (9,878) (10,326) (8,040) Pre Tax Profit (48,683) ,194 59,556 Income Tax Expense ,634 (15,351) Net Profit For The Year (48,683) ,828 44,205 Total Assets 239, , , ,033 Trade and other receivables 6,630 8,783 7,087 6,097 Cash and Cash Equivalents 6,469 21,135 57,050 76,303 Total Liabilities 89,321 83,384 81,409 47,505 Long-term loans 78,684 70,301 68,084 34,549 Trade and other payables 7,080 10,439 8,667 3,501 Owing to directors 3,556 2, Shareholders' Equity 149, , , ,528 Net cash provided by operating activities (44,744) 27,771 50,047 83,344 Net cash used in investing activities (245,319) (4,723) (11,914) (30,555) Net cash used in financing activities 296,532 (8,383) (2,217) (33,535) Net increase/(decrease) in cash and cash equivalents 6,469 14,665 35,915 19,253 Cash and cash equivalents at beginning of years 0 6,469 21,135 57,050 Cash and cash equivalents at end of years 6,469 21,135 57,050 76,303 *Note: The relevant ratios were calculated using the IPO price of $2.00 and assumed issued shares of $353,400,000. Page 2 of 4

3 Profitability Figure 1 The improvement in the company s earning over the period influenced a steady growth in the Company return on average equity which amounted to 21.9% for the June 2017 financial year, up from 0.3% for the June 2015 Expenses For 2017, total operating expenses amounted to $80.7M or 22% higher than the $71.6M for prior year. Over the last four financial years to June 2017, operating expenses reflected a CAGR of 24.5%, largely reflecting higher costs associated with the expansion of the Company s operations over the period. Total operating expenses for the June 2017 financial year were dominated by employee costs, which accounted for 43% of total operating expenses. Employee costs increased to $34.9M at the end of the June 2017 financial year or 46% higher than the prior year figure of $23.9M. Employee costs were mainly fuelled by salaries & wages and staff welfare & training, which increased by 31% to $24.6M and by 72% to $4.9M respectively. Increases in employee costs in addition to increases in advertising and maintenance were attributable to the company s expansion efforts where a new office at 164½ Old Hope Road was established in Meanwhile, finance costs amounted to $8M at the end of the June 2017 financial year or 22% lower than the $10.3M for the prior year. This mainly resulted from the company reducing its long-term debt by 49% to $34.5M as at June 2017 from $68.1M as at June Figure 3 shows the trend in operating expenses. Figure 2 Capital/Financial Position The balance sheet of the Company improved steadily over the last four financial years with shareholders equity amounting to $223.5M as at June 2017; a CAGR of 14.2% over the period from $149.9M as at June For the June 2017 financial year under review, shareholder s equity grew by 25% to $223.5M compared to $179.3M a year ago. This was mainly fuelled by an increase in retained earnings as the company eliminated its accumulated deficit following its relatively strong year-over-year increase in profitability. Figure 4 reflects the growth in the Company s capital base. Total assets grew to $271M as at June 2017 or 4% higher than the $260.7M as at June This was led by a 34% year-over-year increase in cash and cash equivalents to $76.3M. Meanwhile, total liabilities amounted to $47.5M as at June 2017, a 42% decrease from the $81.4M as at June The decrease in liabilities was mainly influenced by the reduction of the Company s debt stock by 49% to $34.5M as at June 2017 from $$68.1M as at June Of note, the Company has generally maintained strong and improving leverage ratios as evidenced with the debt-toequity ratio closing at 0.21 times for the June 2017 financial year; lower than the 0.60 times for the June 2014 financial year. Figure 3 Page 3 of 4

4 September 2017 Quarter Review Figure 4 For the 3-months to September 2017 Elite reported net profits of $14.3M on total revenues of $69.8M. This translated into a net margin of 20.8% which was running ahead of the 16.8% net margin for the June 2017 financial year. Of note, the net income for the 3-months to September 2017 represented a 92.1% increase compared to the $7.45M for the same period of the prior financial year. Revenues however rose by 22.7% for the current quarter compared to $56.88M for the same period last year. Equally important, the capital base of the company continued to strengthen with shareholders equity totalling approximately $237.84M as at September 2017 or 6.4% higher than at the end of the June 2017 financial year. Total assets of the Company grew year-over-year amidst the Company s expansion efforts with assets totalling $357.49M as at September 2017 or 37.2% higher than a year ago. Likewise, total liabilities grew by approximately 62.0% year-over-year to $119.65M owing mostly to an increase in debt which funded the company s expansion. FORECAST & VALUATION Elite s business model of combining strategic business principles with the provision of advanced medical diagnostics services at competitive prices, complimented with continued expansion efforts and the increasing demand for medical imaging services from private and public hospitals are anticipated to support a positive earnings growth trend over the short-to-medium term. At the same time, the use of the net proceeds from the IPO to retire a portion of the company s existing debt stock and to provide working capital is expected to reduce finance costs and by extension influence higher net profits in the near term. The capital provided by the IPO is also likely to bolster the expansion efforts of the Company s operations through investments in new services, equipment and infrastructure. Applying a revenue growth estimate of 25% for the 2018 financial year, a noted discount to the CAGR of 65.2% over the last four years to June 2017 but more consistent with the slowing growth trend realized over the last three financial years to June 2017, total revenues are forecast to reach $328.87M at the end of the June 2018 financial year. Meanwhile, the net margin for the Company is estimated to hold at approximately 22% for 2018 which suggests net profits to $72.35M or earnings-per-share (EPS) of $0.22 for the June 2018 financial year. The net margin is assumed at the pre-tax margin for the June 2017 financial year with the expected tax waiver to be realized on listing on the Junior Stock Exchange. Applying a conservative forward price-toearnings (P/E) ratio of 16 times, the estimated mid-point between our worse and best case price multiple estimates, (at a discount to the current junior market P/E ratio of approximately 22 times) the stock price is likely to trade at approximately $3.28 by the end of the 2018 financial year. This suggests a potential capital gain of 63.8% to the issue price of $2.00. Note however that our estimates of price multiple ranges suggest a best case price target of approximately $5.55 if the stock trades in line with the market average P/E ratio of approximately 22 times and a downside risk of falling to approximately $1.76 assuming the stock trades at the estimated trailing P/E of times as at September At the same time, assuming the company generates the net proceed of $130.36M from the IPO and pays 10% of profits in dividend for the 2018 financial year, the equity position is forecast to reach approximately $290.10M or book value per share of $0.82 as at June Applying a forward price-to-book value (P/BV) ratio of 3.0 times, which is also at a discount to the average P/BV ratio of approximately 4.0 times on the Junior Stock exchange, the share price could trade as a high as $2.46. This represents a potential capital gain of approximately 23% relative to the IPO price of $2.00. RECOMMENDATION Our analysis of the company s financial statements and forecasts suggest that over the short-term the stock is likely to trade at a premium to the IPO price and provide a potential return in the region of 23% to 64% based on our base case price-multiple trading estimates and expected dividend policy of the Company. However, our best case return estimate suggests a potential return of approximately 177.4%. The stock is therefore recommended as a BUY at the IPO price. Page 3 of 4

5 Contact Us Description Key Contact Contact Details Wade Mars, Equity Trading Manager Telephone D/L: ; Switchboard: ; F: For further information on the services offered by GKCM, please contact us at the numbers indicated you may visit our website at: Disclaimer The information contained herein was obtained from sources which GK Capital Management Limited ( GKCM ) considers reliable but we have not independently verified such information and thus do not guarantee that it is accurate or complete as to all material facts and should not be relied on as the primary basis for any investment decision. The information, estimates and opinion contained herein constitutes GKCM s judgment as of the date of this report and GKCM does not undertake any obligation to update them. All expressions of opinions are subject to change without notice. Additional information may be available upon request. The above recommendations are indicative and do not constitute an offer to buy or sell any security or other asset and GKCM is not providing investment advice through this report. Past performance is not indicative of future results and no representation or warranty, express or implied, is made by GKCM regarding future performance. Recipients of this report should perform their own independent review of any security they wish to purchase or sell as well as the issuer of said security and make their own independent decision after considering all relevant factors, including without limitation, their investment needs, objectives and financial circumstances. As such no warranty, express or implied, as to the accuracy, timeliness or completeness of this report is given or made by GKCM in any form whatsoever. GKCM may have a proprietary interest in the securities it recommends, including the above security and as such may trade for its own accounts in any of the securities or assets of issuers mentioned herein or in related investments and may also from time to time perform or solicit investment banking or other services, including underwriting securities for, or from, any issuer mentioned herein. Page 4 of 4