Stockwatch: A volatile FTSE 100 stock for fresh money?

There's plenty of speculation around this blue-chip growth company which has hit the headlines.

Is the bear case on FTSE 100-listed stock NMC Health (LSE:NMC) (NMC) now destroyed by latest results, such that shorting an apparent "growth company" will reverse and enhance upside potential?

NMC, the largest private healthcare provider in the United Arab Emirates, listed at 210p in April 2012, eventually multiplying 18 times when it breached the 4,000p level a year ago on the back of strong financial growth (see table).  

It had been a key European flotation after a torrid 2011 for new share issues, coinciding with the start of a fresh bull market and illustrating how the bull's legs depend on vigorous new stories to run.

On a cautious view. the context for Gulf companies was a tad murky: Damas, a jewellery retailer, had listed in Dubai but after two years revealed its founders had conducted $165 million (£134 million) "unauthorised transactions" that led to a debt restructuring.

So, when Deutsche Bank floated NMC, it insisted it would adhere to standards required by a premium London listing, and one of NMC's founders said that if insiders wanted to act freely then they wouldn't listed in London.

Bear activity has manifested since last November

That the stock peaked in August 2018 and lost a third of its value to 2,700p by year-end looked more to do with the slide in global markets.  However, unlike other stocks, NMC did not rebound in the New Year, and continued to slide until finding a low of 1,800p earlier this month.

A drop from 2,400p coincided with the Muddy Waters hedge fund teasing the market about its next shorting target - "an accounting fiasco" – which proved to be AIM-listed Burford Capital (LSE:BUR), though NMC got caught up in the speculation.  

Source: TradingView Past performance is not a guide to future performance

On 8 August it declared first-half 2019 performance had been "good" with all key metrics in line with management expectations.  Yet the short position has grown consistently since November 2018 - AQR Capital Management last raised its short to 3.61% on 20 August and Portsea Asset Management declared a 0.59% short on 22 August.  A total 6.05% (positions disclosed over 0.5%) may not sound a lot, but NMC has only 41% free float of stock.

This also coincides with US broker Jefferies taking a uniquely critical line against NMC from last November when it cut earnings per share (EPS) estimates and downgraded its rating to 'underperform' from 'hold' – which has proved astute versus all other brokers promoting the stock.  

Chief reasons were scepticism about expansion in Saudi Arabia, management incentives focused on EBITDA in context of high debt, and underlying free cashflow conversion of only around 25%.  More generally, Jefferies suggested disclosure and execution risks.

Blasted by strong 22 August interims

Reporting in US dollars, net profit is up 29.6% to $138.1 million (£112.6 million) on revenue up 32.6% to $1,236 million, on a slightly lower 18.5% operating margin versus 19.3% like-for-like.  NMC also declared a $200 million share buyback programme, as if to capitalise on "exceptional price volatility" albeit selectively due also to "very attractive investment opportunities for the short and medium term".  On a wary view, that comment could also mean it is vital for the company to keep acquiring businesses to show financial growth.

The stock initially jumped well over 50% to test 2,800p, if chiefly due to a Reuters report saying two groups - one backed by the Chinese conglomerate Fosun (presently engaged in a rescue of Thomas Cook Group (LSE:TCG)) - had made competing offers to buy a 40% stake in NMC worth up to $1.9 billion.  The story had authority on the basis of "four sources familiar with the deal" and being run later by the Financial Times and other media.  "The group is looking to pay a premium to market price," two sources said.

But claims in this story don't correspond: "up to $1.9 billion" implies 1,800p a share, which does not square with paying a premium.  Unsurprising, therefore, the stock has fallen back to around 2,170p.  Fosun's interest is logical given it has healthcare interests and is internationally expansive, though it has not confirmed the speculation.

Do latest figures settle critical questions?

At first glance the results are remarkably good, but the sceptic in me wonders if they're a bit too good.

Yes, acquisitions have enhanced like-for-like numbers, but should healthcare be delivering such performance?  

In the UK it would have the left up in arms, generating discussion around how essential it is to safeguard the NHS from private operators. NMC also appears to have industry-leading margins, giving reason to dig deeper into the accounts.

My chief concern is a lack of breakdown of underlying performance versus contribution from acquisitions, making it hard to reject Jefferies' criticism that NMC tweaks its accounts to mask falling profitability in its core healthcare business.  

The CEO refers to "developing niche, differentiated verticals in our core markets that provide the best possible care for our patients" and "2019 remains focused on integration and realisation of synergies from previous acquisitions," but when their contribution is unclear and EBITDA is a prominent yardstick I'm instinctively cautious.

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The end-June balance sheet remains loaded with liabilities: those that are long-term include $863 million term loans, $790 million convertible bonds and $665 million lease liabilities; and under short-term liabilities, a $190 million overdraft, $252 million term loans and $42 million lease liabilities.  

Lumping all these together means $2.8 billion of liabilities in context of $1.7 billion net assets of which $1.6 billion constitute intangibles. 

So, it's a balance sheet true to "acquisitive beast" form, the type a year ago that was liable to trigger fear about the prospect of US interest rates rising, although the Federal Reserve has since shifted stance to rate-cutting.  NMC's liabilities have also generated a net $88.3 million interest charge covered 2.6x by operating profit.  Not great but not portending a corporate crisis either, if recessionary fears keep interest rates low.

Cashflow conversion is another bear point: flattered by supply chain financing, something NMC denies.

A seemingly high period for collecting on bills has also raised concerns (though which may reflect Middle East payment cycles), with interim trade receivables up 10.3% to $705 million versus $267 million trade payables.  But receivables as a percentage of revenue is improving, which could be said the key ratio going forward.

Stock-buyers also likely took heart from operating cash flow up 44.2% to $338 million gross and up 212% to $275 million net.  The cashflow statement also shows investment activities down from $487 million to $53 million, with acquisitions made in the first half of 2018 recently boosting profit/sales. 

A few positive take-ways

Existing shareholders can take some encouragement from these results, yet NMC remains the same beast with excess liabilities and looking acquisitions-reliant to sustain its growth profile.  It is very typical for such stocks to retain their original fan club but also gain detractors.  Sentiment is disrupted hence price volatile.

Having followed acquisitive/indebted groups, and their results for shareholders, for some 30 years, I am fundamentally cautious as they mature.  But I acknowledge that AQR Capital Management has run up a circa £162 million short position here, which is very exposed should NMC file resilient accounts over the next year or so.  

It makes the stock interesting for alert traders, skilled in long and short positions but, for buy-and-hold investors with fresh money: Avoid.

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