Investments Assignment: Financial Analysis of Integral Diagnostics Limited

Question

Task

Investments Assignment Task: You are required to analyse Integral Diagnostics Limited (IDX.AX) and prepare an investment recommendation report. The report provides an assessment of the company's current position and future prospects, incorporating the use of various valuation techniques to arrive at estimates of the intrinsic value of the company's shares.

Answer

The investments assignment is based on the financial analysis of Internal Diagnostics Limited, a firm providing health care services and is based on Australia. The company majorly provides health care assistance to patients located in Australia and New Zealand. It operates through 72 radiology clinics which includes 26 sites that provide comprehensive services(Integral Diagnostics., 2020). The company has three brands namely, Lake Imaging located in Victoria, Apex Radiology located in Western Australia and Imaging Queensland located in Queensland. It has 23 subsidiaries and Lake Imaging Holdings Pty Ltd is the parent company.

The industries in which the company operates are Medical and Diagnostics Laboratories, Health Care and Social Assistance, Ambulatory Health Care Services. The company is not a multinational company it majorly focuses on providing services to several locations of Australia and New Zealand.

Some of the major competitors of Integral Diagnostics are –

1. Hologic which develops, manufactures and supplies medical imaging system, diagnostic products and surgical products for women health care, it’s headquarter are located in Marlborough United States and in Australia at Macquarie park; it is a multinational company.
2. Retivue Company provides retinal imaging technology that helps to ascertain any eye disease at an early stage. The headquarters is situated at Charlottesville in the United States(Cbd.int, 2021).
3. Med Tech Solutions it provides and also retails solutions for equipment related to diagnostic imaging. The headquarters is at Tulsa, United States.

For our analysis we are choosing Hologic as in Australia it is not only manufactures but also provide solutions and services for women health, etc related to diagnostic imaging and the location where it operates in Australia it holds the largest market share with large customer flow.

We would conduct our analysis using the technique of ratio analysis to compare the company’s performance with its peer Hologic. Here, we have collected the data for a period of five years for the companies and calculated five financial ratios to analyse the performance of both the companies and comment thereon.

Calculation of Ratios

 

 

Analysis of Ratios
Working Capital Ratio: This ratio helps to analyse the operating efficiency of a company whether it is able to meet its working capital requirements through short term sources of finance or has to rely on external sources. If a company has more current assets than current liabilities it is said to be operating efficiently as it will be able to meet its short-term obligations on time by liquidating current assets.

Here, from the above ratios we can say that both the companies have maintained sufficient working capitals throughout the tenure of fiver years except for year 2017 when Hologic reported a negative working capital and 2018 & 2019 when Integral Diagnostic reported negative working capital. In the year 2017 an amount of $ 1,150.8 was reported as current obligation of long-term loan to be rapid thus only for that year the working capital became negative. In the year 2018 & 2019 the cash and cash equivalent balance of Integral Diagnostic had fallen drastically which resulted in decrease of overall current assets and negative working capital.

Quick Ratio:This ratio is the most efficient indicator of liquidity performance of a company as it includes only liquid assets in its calculation and items like inventory which are slow moving are ignored as they take time to realise in cash. This ratio is also known as acid test ratio (Tumanggor, 2020).

From our above calculations we can say that Hologic Inc. has reported a better quick ratio than Integral diagnostic in the past five years. Integral Diagnostic has reported low quick ratio in the year 2018 – 0.84 times and in 2019 – 0.88 times as the company’s current assets were not sufficient to cover up the current liabilities. Whereas, in the year 2018 though Hologic reported positive working capital but as the amount of closing inventory was high the quick ratio reported was below 1.

Earnings Per Share: This ratio helps an investor to evaluate the company’s performance and get an idea of return he would be receiving by the company on his investment. Higher the earnings per share better it is as the shareholders are satisfied with higher returns and it becomes easier for a company to allure potential investors.

Integral Diagnostic serves better earnings per share as compared to Hologic Inc. The company Hologic has reported loss of $ 111.3 and $ 203.6 in the year 2018 and 2019 respectively. Whereas, the company’s Integral Diagnostic has been reporting profits continuously and satisfying it shareholders by declaring dividends from the total earnings of the company. Thus, we can say that as the company is making continuous profits and declaring dividends it is more alluring from an investor’s point of view than Hologic Inc.

Inventory Turnover Ratio: This ratio indicates how quickly the company converts its inventory into sales. The higher the ratio the better it is as the company with higher inventory turnover will generate higher revenue and as the cost of holding inventory would also be reduced the profits will increase (Kwak, 2019).

The inventory turnover ratio of Integral diagnostic is quite low as it is mainly focused in providing services to patients, medical specialists & practitioners rather than selling its inventory of goods, equipment and other pharmaceutical products that are required while providing the services. Whereas, Hologic Inc focuses on manufacturing and selling equipment, surgical products, and diagnostic systems thus, it reports a higher inventory ratio in the past five years as compared to Integral Diagnostics.

Interest Coverage Ratio: This ratio measures the number of times a company’s operating profit is sufficient to cover its interest obligations. We can get an idea whether the company would be able to pay off its finance cost or is at the risk of becoming a defaulter from this ratio.

The Interest coverage ratio of Hologic is 9.48 times in the year 2020 whereas Integral Diagnostic reported interest coverage of 5.12 times in 2020. Bot the companies earn sufficient amount of operating profits to pay off its interest obligations. But, Hologic suffered huge losses for a continuous period of 2 years (2018 & 2019) and has reported negative ratio, where as though the interest coverage ratio in 2020 is low but Integral Diagnostic has never reported any loss in the past five years. The amount of loan and interest paid by Integral Diagnostic s quite high thus, the company should focus on reducing its debt obligations to reduce risk.

Calculation of CAPM Return
The Capital Asset Pricing Model is used to calculate the Required Return on Equity and make decisions about additions of different assets in the portfolio. CAPM Model gives us the idea of minimum return required by a company from any asset, investment or project to cover up cost and maintain its earnings(Rossi, 2016).

The formula of CAPM Return (Re) = Risk Free Return (Rf) + (Market Return (Rm) – Risk Free Return (Rf)) * Beta (B)

Risk Free Return (Rf) = 1.48% (Source: worldgovernmentbonds.com) is the risk free rate of return of 10 Year Australian Government Bond.

Market Return (Rm) = 8.90% (Source: Canstar)

Adjusted Beta = (0.67 x Raw Beta)+ 0.332

= (0.67*0.99) +0.332 (Raw Beta (5Y Monthly) = 0.99, Source: Yahoo Finance)

= 0.9953

Return = 1.48% + (8.90-1.48)* 0.9953

= 8.87%

Calculation of Intrinsic Value using Dividend Discount Model (DDM)
The DDM helps to calculate the price of stock based on the dividends will be paid by the company discounted at the rate of expected return (Gottwald, 2013).

Here we have calculated data of dividend payment by the company for past five years and tried to calculate an average growth rate of dividends to use in our calculations.

The average dividend growth rate thus obtained is 17%.

Using the Dividend Discount Model for Multi Stage Growth we will now calculate the intrinsic value of shares=

Do =$ 0.125

G = 17%

Re = 8.87%

Working:

Terminal Value =

*The perpetual growth rate is assumed to be 5%

As the average growth rate of last 5 years obtained was 17% we have used a steady decline method to use multi stage growth model for calculation of intrinsic value.

Relative Valuation
Valuation of Integral Diagnostic and its peer Hologic Inc using Price Earning, Price to Cash Flow per share

The price of shares of Internal Diagnostic as well as Hologic Inc has been rising over the years. Using both Price Earning multiple and Price Cash flow multiple we can say that the shares of the company are undervalued. As Hologic Inc suffered a loss in the year 2019 the true intrinsic value cannot be ascertained and the valuation shows a negative amount. As Integral Diagnostic has been earning huge profits and declaring regular dividends it achieved a steady increase in its share prices over the years.

If we compare the intrinsic value of the shares as calculated above with the price of shares in the stock market it can be said that the share of integral diagnostic are undervalued.

References
Craft.co, 2021. Integral Diagnostics competitors. [online] Available at: [Accessed 2 October 2021].

Gottwald, R. (2013). THE USE OF THE DIVIDEND DISCOUNT MODEL TO MEASURE STOCK PRICE VOLATILITY.J. [online] Available at: http://www.magnanimitas.cz/ADALTA/0202/papers/A_gottwald.pdf [Accessed 2 Oct. 2021].

Integral Diagnostics.(2020). Integral Diagnostics | Medical Imaging Services | Australia | New Zealand. [online] IDX Group | Integral Diagnostics | Medical Imaging Services | AUS | NZ. Available at: https://www.integraldiagnostics.com.au/ [Accessed 2 Oct. 2021].

Kwak, J.K. (2019). Analysis of Inventory Turnover as a Performance Measure in Manufacturing Industry. Investments assignment Processes, [online] 7(10), p.760. Available at: https://www.researchgate.net/publication/336637861_Analysis_of_Inventory_Turnover_as_a_Performance_
Measure_in_Manufacturing_Industry [Accessed 2 Oct. 2021].

Rossi, M. (2016).(PDF) The capital asset pricing model: A critical literature review. [online] ResearchGate. Available at: https://www.researchgate.net/publication/307611046_The_capital_asset_pricing_model_A_critical_literature_review [Accessed 2 Oct. 2021].

Tumanggor, M. (2020). The Influence of Current Ratio, Quick Ratio and Net Profit Margin on Return on Assets at PT. Hero Supermarket Tbk. PINISI Discretion Review, [online] 1(1), p.137. Available at: https://www.researchgate.net/publication/340801971_The_Influence_of_Current_Ratio_Quick_Ratio_and_Net_Profit_
Margin_on_Return_on_Assets_at_PT_Hero_Supermarket_Tbk [Accessed 2 Oct. 2021].