Stockwatch: Should you buy NMC Health after 50% slump?

With the shares having halved in just a few days, we discuss the situation at this FTSE 100 company. 

Are the FTSE 100 shares in this United Arab Emirates’ healthcare provider NMC Health (LSE:NMC) now ensnared by criticism from the US short-seller Muddy Waters and best avoided?  Or has this latest swipe by the ultimate “noise trader” pushed the stock below fair value, offering a Christmas-time gift?

I’ve followed Muddy Waters’ antics for some years now and find evidence of their perspicuity skills to be mixed. Yes, they were prime movers at revealing accounting issues and frauds at Chinese companies, and their interventions are welcome in the sense of challenging opacity. But I’m unsurprised they’ve alighted on NMC Health and, in key respects, it is useful to cast a bright light on contentious issues that have dogged the stock this year – otherwise investors might simply just avoid it.

However, Muddy seems infamous for loaded language in its reports, ultimately serving the interests of those short. The way businesses can be presented as essentially bent and untrustworthy, you might expect the publisher of such reports to maintain its conviction trade. But it’s prone to take its profit as soon as the noise has had maximum impact, which for me puts the integrity of their stance in question. Muddy’s record is also mixed, with some of its target stocks successfully clawing back.

So, potentially there’s something to play for in NMC, though I think it safe to say it’s an intrigue for experienced alert traders rather than a stock to be salted away in an ISA or SIPP. 

There’s a typical pattern, with the swaggering Muddy Waters casting damning aspersions that appear credible, hence smashing even a FTSE 100 stock. Their targets refute the allegations as baseless; Muddy then hits back; sentiment may recover to an extent though can be left damaged.  

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Whatever rights and wrongs, a loud noise trader/publisher like this is occupying a highly profitable niche, able to move markets while regulators seem unwilling or unable to cast their own view about whether such actions promote market efficiency, or constitute abuse.

Not a lot that’s fundamentally new, in this attack

Last Tuesday, Muddy published a series of apparently well-researched allegations about accounting issues, debt and governance, to which NMC made an initial rebuttal early Wednesday. Then, after Thursday’s market close it issued more detailed arguments that came across well. If this situation interests you, most certainly you should consider the arguments both from Muddy Water’s website (according to required consents) and NMC by way of RNS announcements.

This kind of Punch & Judy show now has an established format and I expect Muddy to make a rejoinder possibly with further criticism. A dilemma is its own alleged short position yet to appear in disclosed records, albeit they are based on 0.5%-plus of issued share capital. So, it’s not possible to compare Muddy’s actions with its words, also versus the stock price.

In key respects all Muddy has done is take away existing bones of contention, chew on them a while and return red-in-tooth-and-claw. For example, I laid out an “Avoid” critique last August at 2,170p as the stock continued to fall from its 4,060p peak, despite strong interim results on the 22nd and the declaration of a $200 million (£152 million) buyback programme initially pushing the stock up to 2,800p.  Frankly, it was hard to contain the issues arising within an article.

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I was concerned NMC’s interim figures looked too good to be true, typifying indebted acquirers that end up in controversy. Can, and indeed should, hospitals/healthcare be delivering net profit up 30% near £113 million equivalent, on an 18.5% operating margin?

There was a lack of breakdown of underlying performance versus the contribution from acquisitions, masking like-for-like comparisons. The balance sheet was swollen with $2.8 billion total debt including lease liabilities and convertible bonds, in context of $1.7 billion net assets of which $1.9 billion constituted intangibles. And there was a curiously long period for collecting on bills.

Moreover, among short-sellers, AQR Capital Management had built up a £162 million equivalent short position – borrowing/selling 3.6% of NMC’s total issued equity – a whopper of a conviction trade, and for me underlined my “Avoid” stance.

This situation has wider relevance in the way companies with a low “free float” in their equity may be prone to a lack of transparency, their stocks kicked around by momentum traders. Founder-promoters and their pals may effectively control the situation, potentially giving rise to entitled behaviour.

Yet, amid sensational criticism, the objective question is, after having soared from 175p at end-2012 to 4060p in August 2018, is the stock in a similar downtrend liable to - or already – go below intrinsic value?

Semblances of a worthwhile business, albeit stretched

More positively, the United Arab Emirates is a manifestly wealthy region and healthcare is in genuine demand; so, if Muddy’s aspersions of “fraud” are considered refuted then the stock is likely to settle plenty higher than lows towards 1,450p on Thursday afternoon, before speculation about an NMC statement pushed it over 1,500p.

On Wednesday, NMC had cited a latest buyback of $90 million of convertible bonds due 2025, via cash reserves, to deflect Muddy’s assertions about overpayment for assets, inflated cash balances and understated debt. Management also re-iterated guidance on 21 October, for second-half 2019 performance stronger than the first half which underpinned full-year guidance across all key financial variables including cash flow conversion.

Then, on Thursday, the company said:

“NMC’s strategy continues to offer substantial advantage over competitors in all key markets; consequently 2020 is anticipated to deliver double-digit top and bottom line growth.” Specifically, on margins: “unlike other competitors, NMC has additional service capabilities which results in higher margins” also “other specialised verticals such as IVF and long-term care which are high-margin.”

If the consensus is fair – for net profit to advance from around $249 million in 2018 to $317 million this year and $410 million next, for annual earnings per share growth of 26% to 28%, the stock is roughly (given current volatility) on a forward price/earnings (PE) ratio not much over 10x, hence dividing by the underlying growth rate offers a very attractive PEG ratio around 0.5x.

My concern remains that this is pretty exceptional growth for a company capitalised at around £3 billion equivalent (even after a share price slump). NMC’s refutations don’t contest Muddy’s points how executive compensation has nearly tripled in two years to $18.7 million annually, and insiders have cashed out some $300 million worth of equity, net.

Now, this Friday morning the stock has plunged another 10% to around 1,370p. A report cites NMC holding talks to raise hundreds of millions of dollars of off-balance sheet debt to fund new hospitals, fanning fears its balance sheet doesn’t reflect a true state of affairs. It’s a spoiler for Thursday night’s rebuttal and liable to keep the mood jittery. Investors generally hate situations of complicated debt, where things aren’t what they appear.

Technical support is baked in, if NMC can survive

Yet, the crux is whether NMC’s finances are ultimately manageable, that it chiefly needs to reign in its aggressive expansion or is going bust. Its financials don’t overall look likely to, though having watched enough indebted acquirers run into controversy then trouble, I would be reckless to abandon decades of experience. 

If NMC thrives then short sellers will need to start buying back in a very crowded trade: 5% of NMC’s issued equity may be out on loan but that’s nearer 25% of free float. That’s a very crowded trade and from a risk management perspective it would only take a modest element of short closing, once a wave of selling diminishes, to push equilibrium price up smartly.  Muddy has in other situations appeared to take its profits promptly.

At its current valuation, NMC looks a candidate for removal from the FTSE 100 index, although a review appears some time away, enough for this crisis to abate. Bear this in mind, however.

If NMC insiders buy substantial equity, that’s judged more than a propping up exercise, it could provoke short covering hence a near-term rebound. The allegations, also latest revelation about off-balance sheet finance, may fester though.

For hyper-alert traders, yes, this is a Christmas gift to fascinate – so watch what next may break, or not – in which case this fearful mood will ease and the stock sharply rebound.  Generally, for investors, currently: Avoid.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.