Going through the vast amounts of companies that pass my initial screener, I found Fonar Corp (FONR from here on out), and it caught my attention. With a market cap of $111.9M, this is a small company based out of NY, but it is making a big footprint in the world of MRI scanning. Due to its impressive margins, up-trending balance sheets, and a catalyst in the waiting room (sorry, the pun was there for the taking), FONR appears to be undervalued and trading at a discount to its current share price.
What They Do
FONR operates within the medical scanning industry in two ways: Through production and manufacturing of MRI scanner equipment, and through servicing that equipment. Because of these two facets of the business, FONR operates as both Fonar Corp and Health Management Corporation of America ( or “HMCA”), which is a wholly – owned subsidiary that deals in the servicing of the MRI equipment. HMCA is further broken down into two LLC’s, Imperial Management Services, LLC (“Imperial”) and Health Diagnostics Management, LLC (“HDM”). This may sound confusing, but don’t fret. In July 2015, FONR restructured the HMCA part of their business, making things more streamlined and efficient.
Into the Numbers
Taking a look at the income statement, FONR has seen an impressive trend in EBITDA growth. Over the last year, FONR grew EBITDA by 10%. Looking back three years, FONR averaged an EBITDA gain of 18.30%. Finally, over the last 5 years, FONR averages a 24.20% EBITDA growth rate per year. These growth patterns are directly correlated with FONR’s increase in EBITDA per share. Ranked higher than 67% of its competitors, FONR’s EBITDA per share as of June 2016 is $3.15. Going back to June 2013, the EBITDA per share was a mere $1.80. Impressive growth no doubt.
Gross Profit for FONR has increased from $23.4M in 2013, to $34.50M 2016. Important to note here that FONR’s Gross Margin is 49.12%, giving it a durable competitive advantage over its peers, even though it is a mere $111.4M market cap company. Net income has also risen from $8.57M in 2013 to $15.73M in 2016.
Now, when thinking about medical companies, or any company involved in high-tech production and manufacturing, one crucial area of the income statement I like to scrutinize is the R&D Expense Reports. Conventional wisdom would say, ‘Well if the company is in the field of high tech, it should be spending a lot on R&D.’ Yes and no. There’s a time and place for every major expenditure. For technology companies, R&D expenditure gets either front loaded or back loaded. Take Apple for example. Back in 2007, Apple wasn’t spending that much on R&D, only $781M to be exact. However, since then, Apple has been burning through cash in their R&D department with last years R&D Expense at $10,045M! Increased spending in R&D doesn’t necessarily mean increased competitive advantage. Using Apple again, many would argue that Apple took a major step back with their most recent release of the new iPhone. Sure they spent oodles of cash in R&D, but for what? To take away a headphone jack? Getting back to FONR, they frontloaded all of their R&D expenses, and it seems to be paying off. FONR spent $5.69M on R&D in 2007, and since then has yet to break the $4.0M expenditure.
Less R&D spending doesn’t bother me as much when the company is still beating previous years revenues, and FONR is doing just that. Over the past 5 years, FONR has experience 15.90% average annual revenue growth. However, revenue has declined over the last 12 months. Diving into their 10-Q one reads that their slowdown in revenues is due to the increased volatility in orders for MRI scanners, as well as reduced reimbursements for scanners. However, FONR’s revenues were held up in part to increased revenues coming from their maintenance and servicing sections of their business.
Margins and Ratios
Let’s talk margins. FONR sports margins with most better than 90+% of their industry. Operating Margins are 21%, Net Margins come in at 23.06%, ROE and ROA are 30% and 20% respectively, and finally ROIC is 35.02%, which heavily outweighs its WACC of 15.68%.
Moving on to ratios, FONR is trading at 6.83 times earnings, less expensive than 95% of the companies in its industry. FONR is only trading around 8 times its Free Cash Flow, which compared to the industry average of 29.73, presents a steep bargain. Finally, FONR is trading 2.14 times its Tangible Book and 5 times its NCAV. Going off of valuation ratios alone, FONR seems extremely attractive, however, one last piece of the puzzle remains.
Although the ratios and the margins are good, when it comes to smaller cap companies in the medical technology field, a catalyst is always a welcome sign. Catalysts provide a way for smaller companies to gain leverage over competitors, but also could signal potential buyout opportunities from larger firms in its industry if the technology is tantalizing enough.
FONR came out with The Upright MRI Scanner, which is also referred to as the Stand-Up MRI Scanner. According to FONR’s 10-Q filing, the Upright Scanner is of extreme value because it, “allows patients to be scanned while standing, sitting, reclining and in multiple flexion and extension positions.” This is huge because sometimes deficiencies and problems aren’t seen when a patient is lying down on the MRI table. Furthermore, it gives doctors and technicians the ability to view the joint in question in full ROM (range of motion). This access will be able to help doctors determine even to a more minute level the cause of the problem, and the best way to remedy it.
The good news doesn’t stop there apparently. FONR, in conjunction with its Upright MRI Scanner, helped find a breakthrough in Multiple Sclerosis. The 10-Q goes as follows, “The findings reveal that the cause of multiple sclerosis may be biomechanical and related to earlier trauma to the neck, which can result in obstruction of the flow of cerebrospinal fluid (CSF), which is produced and stored in the central anatomic structures of the brain known as the ventricles” That’s a lot of high level anatomical terms, but here’s the main thesis: doctors discovered that because of FONR’s Upright MRI Scanner.
I would love to get shares around $16.60, and who knows, with the DOW down 200 points today, a consistent bear trend would present this company at even more attractive levels. If it hits $16.60 I’m gonna buy in, it has solid support around that price level going back to 2015 – 2016.