EUR 850.00 For Business Accounts Only

Morningstar | Premier's Fiscal 1Q Results Weaker Than Expected, but Underlying Trends Remain Intact

Narrow-moat Premier reported a mixed third quarter that we think slightly missed expectations on an underlying basis. That said, the firm's adoption of ASC 606 that began this quarter creates meaningful issues with the year-over-year comparability of reported figures. These changes to revenue recognition principles on a go-forward basis will deflate reported growth rates while ultimately leaving profitability unaffected. While there's a lot to dig through in attempting to assess the performance of the business this quarter, we don't see anything that should lead to a sizable change to our $40 fair value estimate.

On a comparable accounting basis, it looks like the firm missed ours and consensus expectations for operating income by nearly $20 million in the quarter. While striking on the surface, we think this is largely attributable to the timing of cash collections related to administrative fee revenue, which pulled recognized revenue into the firm's fiscal 2018 fourth quarter and resulted in a 2.8% year-over-year decline in admin fee revenue this quarter under the old accounting standard. Notably, under the new standard, admin fees will be recognized under the accrual method that will help remove some of this timing-related quarter-to-quarter volatility that masks underlying business performance. Our math suggests this effect likely accounts for $5 million to $10 million of the firm's weaker profitability. Normalizing for this variance, both this quarter and last would have been in line with management's guidance, which continues to imply low- to mid-single-digit admin fee growth for the year.

The other main difference versus our model was weaker-than-expected gross profitability out of the firm's products business, which we estimate also attributed $5 million to $10 million of the operating profit difference versus our forecast. This is likely attributable to mix effects as the lower-margin specialty pharmacy business continues to see growth.

Turning to changes to management's full-year outlook, the performance services and products business lines are now set nearly $50 million lower for the year solely driven by revenue recognition moving from a gross-to-net basis. This lowers expected growth for the firm's products business from 7%-11% under the prior accounting regime to 0%-4% going forward, and places the performance services segment toward the lower end or below the previously announced 1%-5% range. Importantly, the full-year outlook for adjusted EBITDA remains largely unchanged as these adjustments have little impact on cash flow.

Other than changes to revenue recognition, two things stood out to us in the quarter. First, management entered into its first meaningful acquisition since its fiscal 2017 and is planning to close the $51.5 million purchase of Stanson Health in the calendar fourth quarter. Stanson adds to the firm's technology offering with a clinical decision support tool that integrates with existing health records platforms and has a product in the pipeline to help address prior authorization needs for pharmaceuticals in real time. Management indicated the deal will be immaterial to fiscal 2019 results, but we're encouraged to see the company take on a smaller transaction that doesn't demand a sizable portion of the balance sheet.

Second, we're intrigued by both management's reduction in share repurchase activity and hospital member-owners' accelerated exchange of class B shares. After completing the entirety of its $200 million repurchase authorization in the last fiscal year, management purchased only $12 million in stock during the firm's first quarter. During this quarter's exchange window, member-owners swapped 9.8 million class B shares for class A shares, one of the highest quarterly numbers on record and more shares than were exchanged during all of last year. We think this tells a relatively clear story regarding different stakeholders' views on the firm's valuation and helps support our view that public investors should await a larger margin of safety before considering investment.