Two months ago, we detailed one of our holdings, Pacific Smiles (ASX:PSQ). Some investors asked, “Why would you invest in a growth company at a PE of 30 in a high inflation and raising rate environment?”
In this post, we talk about why we invested in PSQ in the current environment.
High patient fee growth
PSQ’s patient fee growth rate has outpaced the growth of the dental market. PSQ’s same centre patient fee is growing at an average of 5.4% before COVID whilst non-government expenditure on dental services increased from $5,474 million in 2008 to $8,068 million in 2018, representing an average annual growth rate of 4.0%.
PSQ manages to deliver this high growth through increasing the portion of higher margin services. A young PSQ centre mainly offers routine services (preventative, restorative and diagnostic). As the centre matures and dentists build a good relationship with their patients, they start offering high margin services, for example teeth whitening, root canals, orthodontic services etc.
Currently around 80% of PSQ’s revenue is still derived from routine services. Thus, the shift in services offering will continue to expand the revenue and profitability of the centres.
We believe PSQ will be able to increase their fees and service offering to outpace inflation.
Clear growth pathway
PSQ has two growth paths. In the short term, 45% of the centres have been opened for fewer than 5 years. A significant portion of its centres are approaching profit maximisation and driving PSQ’s profit growth in the next five years.
As a long-term strategy, PSQ recently announced that it is planning to open more than 20 centres per year, upgrading from 15 centres per year. The company chooses to open new centres rather than make acquisitions. This is a lower risk approach as greenfield development usually is more repeatable. We now assume the company will be operating 250 centres by FY25, up from 94 in FY20.
Conclusion
Due to the sentimental shift between value and growth stocks, we take a cautious approach and are very selective in growth companies. We believe PSQ is resilient to inflationary pressure and will provide good returns to us in the long term.
Till next week, happy investing.
Michael and Kenny
