Is Pro Medicus (ASX:PME) priced for perfection?

Shares in med-tech market darling Pro Medicus (ASX:PME) have carved out fresh record highs recently, following a more than doubling in the share price over the past 12 months.

Recently, the developer of the Visage imaging software got a further kick-along after stockbroker Morgans initiated coverage with a bullish price target of $23.69.

The broker has made some very ‘robust’ growth assumptions to support their valuation, including a 65% increase in sales and a 110% jump in profit over the next two years. Nevertheless, on the published target price, that still leaves shares in Pro Medicus on ~33x sales, or ~71x earnings for FY2021.

If anything justifies the price, it’s the broker’s expectation for the business to increase market share from 4% to 29% by 2028, sustaining an average annual sales growth of ~26% and growing operating margins to ~83%. That’s not impossible, but 10 years is a long time — especially in tech, and especially with loads of extremely well funded and capable players in the industry.

So the questions are:

Can Pro Medicus maintain sufficient technological and service superiority to capture such a large chunk of the global imaging market? Does the business have a strong enough ‘moat’ to defend such lofty margins over an extended period of time?

Even then, if all of the assumptions from Morgans prove accurate, Pro Medicus will need to attract a P/E of at least 25 at maturity to deliver investors a 10% average annual return, ignoring dividends. A P/E of 40 in 2028 is needed for a 15% average annual return.

That’s certainly not impossible, especially for a company that has delivered such heady growth and commands an extremely strong industry position.

Nevertheless, investors must be mindful of the asymmetry of potential returns.

With such strong assumptions already baked in, it’s difficult to justify forecasting even stronger sales/earnings growth, better margins and higher terminal multiples.

But you don’t have to reduce any of Morgans’ assumptions too much to get a less spectacular story, such is the nature of compounding high rates of growth over an extended period of time . For example, if Pro Medicus ‘only’ achieves average annual sales growth of 22% through to 2028, and an EBITDA margin of 80% (compared to their assumptions for 26% & 83%, respectively), then net profit for 2028 will come in ~30% lower than they expect.

There’s no argument that Pro Medicus is an extremely well run business, with a world-leading product and loads of growth potential. It’s debt free, has heaps of cash and operates in a very defensive and fast growing space. But, at present, the phrase “priced for perfection” seems apt.

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