We raise our fair value estimate for narrow-moat Pro Medicus PME by 2% to $46 per share, largely due to a strengthening US dollar and the time value of money. Our constant-currency earnings estimates are broadly unchanged. We expect further contract wins to underpin earnings growth. To this end, the firm announced a contract win with the University of Kentucky for a total committed minimum value of $33 million over nine years. Planning for the rollout is commencing immediately based on Pro Medicus’ established cloud-based implementation and we assume a two-month earnings contribution in fiscal 2025.

Pro Medicus remains materially overvalued, with a lot of good news baked in. Shares currently trade over 170 times our forecast fiscal 2026 earnings per share. While some smaller radiology groups are willing to pay a premium for Visage 7, we still anticipate wider uptake to be slow. Visage 7 resonates most with US academic hospitals and large healthcare systems that have a greater interest in advanced visualizations. However, management believes that even some top hospitals don’t require the best technology in the market, even in terms of speed and quality of images. We also expect downward pressure on the average size of future contracts as the more lucrative academic hospitals market inches closer to saturation.

Our midcycle EBIT margin forecast stands. We forecast EBIT margin to increase slightly to 73% by fiscal 2034 from 70% in fiscal 2024. While the firm has great cost control, we think the research and development spending required to stay competitive in the long term will limit margin expansion. There are low barriers to entry in the industry, and competing products such as Philips’ HealthSuite platform are catching up by utilizing or exploring similar technology such as server-side rendering, cloud-native architecture, and artificial intelligence.

Business model is sound, but shares screen as expensive

Pro Medicus’ strategy revolves around renewing existing contracts and winning new clients for its main product, Visage 7, while increasing its price point. The company won six out of six major public tenders it competed for in fiscal 2021, which often involved on-site pilot tests. While this likely highlights Visage 7’s current superior speed, scalability, and resilience, continued investment in research and development is imperative for the firm to remain at the forefront of innovation and consistently win contracts. Most of the firm’s expenses are allocated to over 40 software engineers with the main R&D center located in Berlin. The company also recently extended its R&D capability in New York in collaboration with NYU Langone Health in 2021. Its R&D efforts mostly revolve around software enhancements, program extensions, and research in artificial intelligence to assist in diagnoses.

Many of Pro Medicus’ competitors already utilize server-side rendering and cloud-native architecture. Legacy systems are also mostly owned by larger competitors such as GE Healthcare, Fujifilm, and Philips that will be incentivized by the high returns in the industry. In Australia, Sectra won a AUD 85 million 13-year deal over Pro Medicus with NSW Health for both its Radiology Information System and Picture Archiving Communications System in 2020.

Visage 7 has found most success with US academic hospitals and in fiscal 2022 was in nine out of the top 20 ranked US hospitals, more than double its nearest competitor. While Pro Medicus has secured a few contracts with midmarket US hospitals such as Allegheny and Wellspan, wider uptake has been slow with Visage 7’s features likely superfluous for their normal operations. However, Pro Medicus is still targeting smaller radiology groups that seek to consolidate IT infrastructure and become more efficient.

Currently, Visage 7 is limited to radiology departments, but Pro Medicus is aiming to extend the product set to other specialty departments including cardiology and ophthalmology. In addition, when winning contracts, the firm has other product offerings such as Open Archive or Visage RIS that it can cross-sell to clients.

PME bulls say

  • Pro Medicus is well positioned to benefit from industry tailwinds such as cloud adoption, larger datasets, and remote access.
  • Earnings are extremely defensive due to contracted revenue being largely guaranteed over five to eight years from customers.
  • The long-term growth opportunity is significant as most of the US market still uses legacy systems and other geographies are largely untapped.

PME bears say

  • Product differentiation is unlikely to be durable, with low barriers to entry and larger competitors already utilizing server-side rendering and cloud-native architecture.
  • Wide adoption outside of academic hospitals is unproved, and superior speed and visualizations are likely superfluous features for the average hospital.
  • Future contract wins are likely to be smaller as Pro Medicus already dominates the larger US academic hospital market.

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