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Morningstar | Premier's Full-Year Results Exceed Expectations and Reinforce Our Narrow Moat Rating; Raising FVE

Narrow-moat Premier reported fiscal fourth-quarter and full-year results that modestly exceeded our expectations. We intend to raise our fair value estimate to roughly $40 per share as we modestly bump up our forecasts and incorporate the cash flows received since our last update. This implies a valuation of 14 times and 8.7 times our revised estimates of adjusted earnings and EBITDA for fiscal 2019.

Throughout the year, the company improved on all the relevant metrics that help support its narrow economic moat, in our view. In its group purchasing organization, Premier increased the dollar value of hospital supply spending flowing through its contracts by over 7% to roughly $60 billion while maintaining a 98% retention rate. Importantly, this was during the period in which the GPO members' initial contracts were up for renewal. Management indicated that 96% of total net administrative fee revenue earned in fiscal 2018 came from contracts that were renewed, extended, or had a longer duration than the standard five-year period. The fact that nearly all the company's membership has renewed at similar economic terms is a testament to the value Premier provides through its procurement operations.

In the performance services segment, management reported a 97% renewal rate, an all-time high in Premier's time as a public company. While the absolute performance of this business has been lackluster--up only 2% for the full year--due to uncertainty around regulatory requirements, management's 2019 outlook calls for relative growth acceleration, which we find encouraging.

For fiscal 2019, management expects 4%-8% companywide growth supported by low-to mid-single-digit growth in net administrative fee revenue, 7%-11% growth in the products business, and 1%-5% growth from performance services. These assumptions largely bracket our expectations, although we broadly skew toward the higher end of these ranges.

Premier ended the year with roughly $150 million in cash on hand and $650 million in untapped liquidity available on its revolving credit facility. Management intends to continue to search for tuck-in acquisition candidates that fit well with its existing analytics and supply chain platforms. That said, target valuations remain elevated, and we believe the firm's $250 million buyback authorization is a reasonable alternate avenue for capital deployment should the right deal not materialize over the coming year. Importantly, management's earnings guidance of $2.60-$2.72 per share does not include the benefit of a reduced share count due to any potential buyback activity.

We're starting to see cash conversion improve, with adjusted free cash flow representing 62% of adjusted EBITDA for the full year, versus recent performance that has been consistently in the 40%-50% range. Additionally, management is calling for this metric to exceed 50% in 2019, roughly in line with our thinking. While much of this increase is attributable to the sizable run-rate tax benefits Premier should see as a result of the lower corporate tax rate, we think this is an important metric for shareholders to monitor, given the complexity inherent in the company's ownership structure.