ModivCare: Reaffirm Hold As Operating Headwinds Continue (NASDAQ:MODV)

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Investment Summary

Since our last report on ModivCare Inc. (NASDAQ:MODV), we’ve remained firmly neutral on the mid-term outlook for its stock price. We covered MODV in depth in Q2 FY22. From that note, we thought there were several headwinds in the investment debate that reduced both price visibility and upside potential on a forward-looking basis. Just to remind our readers, here are the key take-outs from our previous publication.

  • Tightening return on invested capital and bottom-line growth
  • Tightening margins vertically throughout the P&L, including FCF margin tightening since FY20′
  • Lack of upside capture based on forward estimates.

Turning to the company’s latest quarter, we scrutinized MODV in greater detail and noted similar trends continued during this period. Chiefly, ongoing increase in service expense[s], extension of the ROIC/FCF downtrend, and EPS growth should remain negative into the periods to come. Collectively, these are unattractive numbers for our global equity strategy. We rate MODV a Hold, but revise our price target to $84.75.

MODV 2-year price evolution [weekly, log scale].

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Data: Updata

Nil change to these after MODV Q3 financial results

Flipping back to the company’s numbers, we noted several headwinds across what was a relatively mixed quarter for MODV. We should first mention, however, the company’s growth vision that was on full display in its Q3 investor presentation.

Management noted it remains prioritized on growing its relationships with supportive care services and managed care organizations (“MCO”). It believes there is incremental value in “integrating and bundling our mobility and home services together”; subsequently, it concurrently believes the company’s total addressable market (“TAM”) has widened from $80Bn to $150Bn “over the next few years” [Exhibit 1].

Exhibit 1. MODV estimates its TAM will widen from $80Bn to $150Bn “over the next few years”, by ‘bundling’ its mobility and home services divisions together.

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Note: Image taken from MODV Q3 earnings presentation. Source was quoted as: “(1) ModivCare and third-party estimates (1) represents 2019-2024 personal care services market growth (2) 2020 remote monitoring core serviceable market and CAGR through 2025 (3) Represents meal delivery addressable market through 2024 (4) 2021 market plus $4Bn medicare advantage market opportunity and $6B NEMT market opportunity (Data: MODV Q3 Investor Presentation)

As we turn to the financial highlights, we observed a mixed performance throughout the P&L. For instance, revenue grew 31% YoY to $648 million. The upside was underscored by a 23% YoY growth in the mobility business, and 43% YoY expansion in its personal care segment.

MODV recognized this on adjusted EBITDA of $52 million and core EBITDA of $37.33 million, up ~46% from the same time last year.

Yet, it pulled this down to a GAAP loss of $2.03 per share, well below the negative $0.54 EPS the year prior. For reference, it printed non-GAAP EPS of $1.61 per diluted share.

By the way, we also observed numerous challenges in the financial results as well. For instance:

  1. Q3 service expenses increased ~34% or $135 million YoY to $534 million, increasing to 82.5% of turnover [Exhibit 2]. As a reminder, service expenses include purchased transportation, operational payroll and other operational related costs. The hefty increase stemmed from an $83.4 million YoY lift in purchasing services costs within its non-emergency medical transportation (“NEMT”) segment. Transportation costs were also a factor along with labor. Moreover, the company repackaged costs associated with its Care Flinders acquisition into the service expense of its purchased services division. A full breakdown of Q3 service expense is seen in Appendix 1 at the end of this report.
  2. Management have renegotiated several contracts regarding transportation costs per trip. Chief reason behind the change was, again, input costs like fuel and labor expenditure. The advantage of this move is that it flattens large fluctuations in memberships and costs/expenditures. The downside is that it limits operating margin growth, and therefore compresses the potential for earnings upside further down the line.
  3. Meanwhile, we observed that negative coupling between free cash flow (“FCF”) and return on invested capital (“ROIC”) extended into this period as well. Last time, we explained that FCF yield and ROIC “have continued to narrow on a sequential basis”. This time, we checked actual FCF [vs. FCF yield, removing the effect of market capitalization] and observed the trend remains well in situ [Exhibit 3]. As FCF outflows continue into the red, ROIC has followed suit. FCF is in the red; however, MODV is not seeing the return from these outflows.
  4. Moreover, we decided to break the company’s ROIC numbers down into their sub-components and see where the erosion in value is stemming from. You can see in Exhibit 3 that whilst invested capital turnover has remained flat at ~0.5-1x since FY16, MODV’s NOPAT margin has been compressing off its Q3 FY20′ high. In fact, moving back across the testing period, we note MODV hasn’t delivered any NOPAT margin upside to date. This would explain a lot of the destruction in FCF and ROIC in our opinion. This also helps confirm our neutral thesis.

Exhibit 3. Trend in FCF to ROIC remains well in situ. Last time we checked FCF yield but this time, we looked at FCF flows in total to remove the effect of market cap. As seen, there’s little change to the historical data.

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Data: HBI, MODV SEC Filings

Exhibit 4. So we decided to break ROIC down into its contributing factors. As seen, MODV has delivered no NOPAT margin upside over the past 7 years [28 quarters].

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Data: HBI, MODV SEC Filings

Forward estimates confirm neutral view

We also noted that, in January this year, MODV made some accounting changes by adjusting the estimated useful life of its Simplura trademarks and intangible assets from 10 years down to 3 years. The company did the same for its payor network, adjusting from 15 to 10 years. It did this after the acquisition of Care Flinders.

We should point, however, that the adjustments have an impact on the company’s reported earnings below the EBITDA line. Therefore, we opted to use non-GAAP estimates for the company looking ahead to reconcile for these changes. Hence, from hereon in, all references to EPS are to non-GAAP measures. A more comprehensive explanation on the changes is found in the company’s Q3 FY22 10-Q, page 10.

As such, we project ongoing EPS downsides on a sequential basis into Q2 FY23 [Exhibit 5]. In particular, we see a 14% YoY decline in FY22 EPS forecasts to $6.78 per share, stretching up by 13% to $7.69 the year after.

These aren’t attractive growth percentages at the bottom line in our estimation. Hence, the lack of EPS upside downstream also confirms our neutral view.

Exhibit 5. MODV FY22–24′ growth assumptions

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Note: EPS assumptions are listed in reconciled format to non-GAAP. (Data: HBI Estimates)

Valuation and Conclusion

Consensus values the stock at 12.5x forward non-GAAP earnings. Compare this to the S&P 500’s 18.18x forward P/E estimate, we believe the market expects MODV to underperform the benchmark.

In our last publication, we valued MODV at $103, noting the stock appeared fairly valued at the time. We’d just remind investors that our price targets are mobile and reflective of new information/data into the debate.

As such, we’ve revised our MODV price target down after its Q3 results. We agree with consensus’ view on 12.5x forward P/E and believe this is a fair multiple for the stock to trade at.

Rolling our FY22 non-GAAP EPS estimates forward, and applying the 12.5x multiple derives a price target of $84.75. As was the case in our last MODV note, we see the stock as fairly valued at this multiple. Hence, we reaffirm our hold rating at $84.75.

Appendix 1. Service expenses lifted to 82.5% of turnover primarily from delta in the purchased services division

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Data: MODV Q3 FY22 10-Q, pp. 10

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