Agiliti: Mid-Term Growth Drivers Now Tight Following HHS, Guidance Updates (NYSE:AGTI)

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Investment summary

We are neutral on Agiliti, Inc. (NYSE:AGTI) shares after the company narrowed revenue expectations from its Health and Human Services (“HHS”) agreement from previous FY22 guidance. The impact is likely to have a material impact on the stock’s ability to re-rate back to the upside. I’ve noted the market’s muted reaction to an otherwise solid set of numbers for Q2 FY22, and after careful analysis of the company’s business model and its earnings prospects, believe shares are fairly priced with little upside capture on offer. Net-net, I rate AGTI a hold until the company can demonstrate a replacement in revenue from the HHS agreement overhang.

AGTI 6-month price action. See the divergence in long-term trend indicators [bottom window] and price distribution.

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Data: Refinitiv Eikon

Key catalyst – HHS agreement overhang

Despite the miss versus consensus at the top line, management reiterated FY22 guidance and this points to several curious factors looking ahead. Firstly, previous guidance baked revenues against a comp of $30–$40mm of Covid-19 revenue from FY21. However, equipment utilization levels actually dropped below pre-Covid levels during the quarter, nullifying this forecast. Management now foresee a $39–$40mm negative impact to revenue from this in FY22.

It also assumed revenue from the new HHS agreement would generate $40–$50mm at the top this year. However, AGTI learned during the quarter that certain time and materials work will remain fluid and be deferred until a new HHS contract is awarded. The full impact of this change is expected to be $10–$15mm adjustment to revenue from last year.

In addition to the above, management also noted “the rental portion of the business” as the second reason for the variance. Per CFO, Jim Pekarek on the Q2 earnings call:

“We have previously described the net COVID impact of higher medical device utilization in 2021 is a $30 million to $40 million full year benefit to revenue. We further define this tailwind as the excess of COVID-driven rental revenue in 2021 over the 2019 pre-COVID baseline utilization for our rental fleet.”

However, this ‘excess tailwind’ has certainly wound back with the reduction in Omicron-led demand, presenting AGTI with a $20–$30mm net reduction in revenue from initial guidance.

Q2 earnings: Mixed, but not terrible

Second quarter earnings were mixed with a 900bps YoY growth in revenue to $724 million (“mm”). Segmentally, the equipment solutions business came in with $107mm [$0.80/share] and grew 48% YoY, with the Sizewise acquisition showing quarterly revenue accretion of ~525bps or $38mm [$0.02/share]. Turnover in the clinical engineering segment grew 300bps YoY to $104mm and tightened up secondary to the lower HHS agreement revenue, particularly as ATGI moves towards longer-term pricing levels associated with ongoing maintenance of its stockpile devices.

Meanwhile, revenue from on-site managed $63mm and narrowed by 19 percentage points YoY. The decrease, again, stemmed from the revised pricing as a part of the HHS agreement, and therefore was expected. It bought this down to operating income of $16mm after a 130bps YoY increase in SG&A for the 12 months.

However, we note this increase in SG&A included a $21.5mm non-cash amortization expense, as noted in the company’s Q2 FY22 10-Q. AGTI capitalizes contract costs that incurred in obtaining new contracts. It books these as investments under ‘other long-term assets’ on the balance sheet. It then amortizes these over an estimated useful life of 5-years. Total capitalized costs during the 2nd quarter were $17.9mm.

Also, there was a $69.5mm non-cash depreciation expense associated with the company’s plant, property and equipment (”PP&E”) asset value, and this was recognized in cost of revenue, as noted by the company in the 10-Q. AGTI’s depreciation schedule for the 6-month period to Q2 FY22 is seen in Exhibit 1.

One positive takeout from the quarter was AGTI’s FCF conversion of $13.6mm, although this too remained down on longer-term trends. The realized FCF yield on this comes in at 58bps and 450bps on a TTM basis using the company’s latest market capitalization. Meanwhile, TTM return on investment (“ROIC”) was 410bps for AGTI, but TTM return on its existing capital/assets was a tight 190bps and neither figures cover the WACC hurdle of 8.4%, which could be a risk to earnings looking ahead in my estimation.

Exhibit 1. For the 6-months of December 2021–June 2022, straight-line depreciation of PP&E. AGTI books amortization and depreciation in its SG&A and cost of revenues, respectively.

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Note: Q2 FY22 non-cash charges of $91mm are recognized in cost of revenue and SG&A. Additional amortization costs are recognized on operating leases, finance lease assets and issuance of common stock related to acquisition. See: Note 6, Property and Equipment Q2 FY22 10-Q pp. 11–13. (Data: AGTI Q2 FY22 10-Q)

Valuation and conclusion

Shares are trading at a premium to peers at a 94x TTM P/E however look to be fairly priced at ~2.6x book value and 2.2x sales. Consensus estimates have AGTI to print $1.03 in EPS for FY23 per Bloomberg and Refinitiv consensus data, and this is a satisfactory number by my estimation that aligns with our own internal GAAP EPS estimates for the company. At ~18x the forward estimates of $1.03 for FY23, this sets a price target of $18.54, suggesting a small percentage [~6.2%] of upside potential from the current share price. This aligns with the neutral thesis I’ve prescribed for the company throughout this report.

Exhibit 2. Multiples and comps

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Data: HB Insights, Refinitiv Datastream

With the points raised throughout this report there appears to be a lack of upside capture in AGTI when looking ahead. The HHS agreement overhang is set to be a meaningful headwind for the company on a forward looking basis, and until further clarity on this is obtained. Shares also look to be fairly priced with the market pricing AGTI at ~18x forward earnings, also a 16% discount to the GICS sector peer group, suggesting investors are expecting a below-sector earnings result from the company in FY23.

As investors look to step up in quality to position for an extensive economic downturn, and to mitigate volatility of portfolios, there may be better names on offer to achieve these desired results. Net-net, I’ve rated AGTI a hold on the culmination of these factors, and look forward to revisiting the name.

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