FatCamera
Newly listed American Oncology is a healthcare stock with ample growth potential, but is still quite speculative at this point.
Thesis
Over the past five years, American Oncology has grown rapidly, and is likely to stay on that trajectory. However, it is a microcap with a somewhat uncertain valuation and thin margins.
About American Oncology
This microcap healthcare stock is a newcomer. It first traded on the Nasdaq on September 21, 2023, after finalizing a business combination with Digital Transformation Opportunities Corp., a SPAC entity that became defunct the day after American Oncology began trading.
The cancer-care firm was established in September 2018 and in the past five years it has grown to 1,500 employees and over 200 practitioners in more than 75 clinics serving 450,00 patients. In a news release announcing its public trading, it explained,
“AON practices have access to fully integrated ancillary services such as a specialty pharmacy, lab and pathology, radiation therapy, and imaging. These services encourage clinical coordination and seamless communication throughout all stages of the care process. AON practices deliver high-quality patient care by sharing resources and expertise across the network, providing access to leading clinical trials, staying at the forefront of clinical innovation, and advocating for their patients and the profession of community oncology.”
Competition
The company uses a community-care business model that focuses on treatments in clinics and the home of patients, rather than in hospitals. Other firms using this model include the privately-held U.S. Oncology Network, and OneOncology, which is being acquired by AmerisourceBergen (ABG.DU). Both are significantly larger than American Oncology. However, according to American Oncology’s Investor Presentation of September 2023, the market is big:
AONC Large market opportunity (AONC Investor Presentation)
Healthcare competitors with similar market caps include AirSculpt Technologies, Inc. (AIRS), Viemed Healthcare, Inc. (VMD), InfuSystem Holdings, Inc. (INFU), and Talkspace, Inc. (TALK).
Growth
Another slide from the presentation shows how American Oncology has rapidly grown its revenue over the past five years:
AONC Performance (AONC Investor Presentation)
Its profitability, as measured by adjusted EBITDA, is less predictable. As the slide shows, it dropped in 2021 because of a major capital expenditure. And, expect 2023’s adjusted EBITDA to fall advance, because of an additional $24.5 million in transaction costs (expenses connected with going public) in the third quarter. Once those costs wind up, the bottom line should be more consistent.
What’s the outlook for future growth? Quite strong, with what it calls ‘multiple levers’ for growth:
Four levers for AONC growth (Investor Presentation)
As an example, it reported in its third-quarter earnings release that it had grown its network over the previous three months by entering the state of Florida, setting up its first urology practice, and adding 19 new providers.
Generally, healthcare has been a growth industry, and is expected to be one in at least the near future, with aging populations, new therapies, and more.
Margins
admire many relatively small companies entering the publicly traded markets, American Oncology’s financial results are distorted by the relatively high one-time costs. This normalized (no one-time or non-recurring charges) income statement shows the firm would have been profitable without those costs:
AONC normalized income statement (Author)
The company suffered losses from operations in the third quarter and the first nine months, mainly because of transaction expenses: $24.6 million in Q3 and $29.9 in the first nine months. They included legal, accounting, and consulting fees involved in its business combination and going public. As noted, those fees should be eliminated or much lower next year.
It also incurred a one-time, non-recurring loss of $4.8 million in connection with the closing. This expense is included with the cost of revenue.
Without those expenses, revenue and operating expenses would have been positive in the third quarter: $336.3 million in revenue and expenses of $331.3 million. That’s a profit of $5.005 million, or a 1.49% margin.
American Oncology did see a $39.0 million revenue enhance in Q3, but at the same time, its cost of revenue (including that one-time expense) rose by $43.2 million. The volume of patient encounters increased its cost of revenue by $13.4 million, while its cost per patient confront was up $24.2 million.
Whichever perspective we use, the net margin is low. However, there is a good possibility the company can couple its expansion with cost controls to produce better margins in coming quarters.
Management and strategy
Chief Executive Officer Todd Schonherz has headed American Oncology since its inception in 2017. Prior to that, he was Chief Operating Officer at Florida Cancer Specialists and Senior Vice President and Chief Information Officer for US Oncology.
David H. Gould, the Chief Financial Officer, joined the company in September 2020. Previously, he had served as Chief Financial Officer at ApolloMD and Vice President of Finance and Assistant Treasurer at Cumulus Media, a publicly traded, broadcast media and network company.
American Oncology also has an advisory board with 23 medical professionals.
Its strategy going forward is four-pronged:
Four-pronged growth strategy at AONC (AONC investor presentation)
One of the advantages of a network, as compared to a single practitioner or clinic, is the amount of data it can gather. The more participants in its system, the greater the amount and range of data that can be used to make better healthcare and business decisions. As it points out in the presentation, larger platforms also savor purchasing scale, broader recruitment, and increased access to the ‘various constituents’ such as pharma, clinical trials, and payors.
Networks are an effective business model for healthcare businesses, and American Oncology should be able to evolve into a growing and profitable corporation.
Valuation
While the company has operated for five years, it only began trading publicly a few months ago. That means most data and ratios we use for valuation are unavailable. Also, since we have no company or analyst guidance for 2024, we have to use trailing 12-month [TTM] rather than forward ratios.
The stock closed at $6.05 on Tuesday, December 5, 2023. Since going public, shares have traded between $20.50 and $5.77.
The healthcare sector has an average TTM price-to-earnings or P/E, ratio of 17.87. Using the normalized earnings displayed above, I reckon American Oncology’s P/E [TTM] to be 6.44 ($6.05 / $0.94). That’s nearly one-third of the sector median.
The sector’s TTM price-to-sales, or P/S, ratio is 3.64, while American Oncology’s is 0.03, indicating deep undervaluation. As this excerpt from SeekingAlpha’s valuation page for the company shows, it barely registers against the sector median:
AONC price-sales ratio (SeekingAlpha)
While these two indicators propose undervaluation, the market has had a different view, lately. For seven consecutive days, the price has fallen, from $8.73 on November 24 to $6.05 on December 5, a 31% reject.
Both ratios tell us the stock is undervalued. Considering that, plus the wide variations in price since going public, suggests that risk-tolerant investors might see the current price as fair and enter when the current slump bottoms out.
Risks
American Oncology is a microcap. As such, it has the potential for sharply higher and lower prices, but swings should moderate over time as the firm builds a history as a publicly traded company.
Because it has little history as a publicly traded stock, investors have few solid data points on which to evaluate its present valuation.
Its margins, at least those we have now, are thin. If they don’t enhance significantly, and produce more free cash flow for growth, the company may use up its $90 million cash stockpile.
At the same time, pushing for too much growth or too much too soon, could also direct the company into a perilous financial situation.
The oncology industry has many competitors that could take away its market share or push prices down to the point where it has low or no net income.
As it pointed out in Form S-1 of October 13, 2023, “A significant portion of our revenue is derived from a limited number of health insurance and medical group companies.”
Conclusion
American Oncology went public two and a half months ago, after operating as a private company for five years. Over those five years, it built a growth platform and the company intends to widen the scope of the platform in coming years.
Current margins are inadequate to fund significant future growth, but it does have $90 million in cash. Management has suitable encounter, and its four-pronged strategy should be effective. The shares appear undervalued, but may not have bottomed out yet.
For investors who want an idea for the speculative section of their portfolios, American Oncology is a buy.
