I am optimistic about the HSA market. It is going to grow at least 6-7 times the market which we see today. And Suppose health equity is going to keep the leader position and keep building on assets. In that case, there is a genuine chance that the company can grow revenue and stock price proportionately. But the question remains if I am comfortable with the valuation.
I have seen easier to understand financial reports than Heath Equity. I need to get better at evaluating companies that are burning cash for growth. Health Equity has a lot of moving parts. I admit it’s not easy to comprehend. I don’t have a company with which I can compare apples to apples. So I would need to make some conservative assumptions. Warren Buffet once said, “I would rather be vaguely right than precisely wrong.”
Assuming Health Equity will maintain its position in the HSA market, At maturity, It will own around 100 billion dollars of assets. They will have recurring monthly revenue and substantial custodian revenue. I need to understand the revenue they can generate with those assets based on what they have achieved in the past. As the past is not a guaranty of the future, This assumption itself is pretty big. I will take cues from the FY 2019 financial reports before the start of the WageWorks saga.
In FY 19 years, HQY had 8 Billion in assets and made 287 million dollars in revenue. As their operating margin was 27%, they were making 74 million dollars in income. The stock price was around 65, and PE was 55.
Lately, Operating margins have dropped to just 10%, but I guess they can do better than that, So let me take an average operating margin of 15%.
As the total addressable market (TAM) is estimated to be 600 Billion to 1 Trillion dollars, They will own 120 billion dollars HSA assets using lower estimates. Still, I will use 80 billion for the worst case. If 8 billion produces 287 million in revenue, then 80 should produce ten times. With an operating margin of 15%, We can assume they will make 430 million dollars in income. As health equity is notorious for diluting shares, we can imagine they will add 30% more shares in the future, which takes the tally of outstanding shares at 105 million. With no dividend, future EPS should be around 4$. Assuming a mature company like HQY will have a PE of 25 would take the stock price in the vicinity of 100$. Similarly, I can imagine the worst case, best case & exuberant case, and their corresponding probability. If I assume a 10% probability for worst & exuberant case and 40% each for regular and best conservative case, I can come up with the stock price of HQY in 10 years which would be 135$.
As my expected personal rate of return is 12% annually, I want my investments to triple in ten years. So, I would love to buy Health Equity at around 45$ with a margin of safety.
Over the period, Things will evolve. Interest rates are expected to rise three times by the end of 2023, which is a piece of good news for companies’ custodial revenue providing tailwinds. The company should see a spike in revenue, translating to income, and the market can react exuberantly. Cross-selling is one unscratched potential which means the revenue can jump exponentially. They may stop diluting shares in the future. But all these are in the future, which no one knows and how things will turn up. I will like to see it in financial reports instead of guessing. I like the industry, company, and what they have achieved in the past. I will closely follow it and re-evaluate in the future, but I am just going to wait for now.
Disclaimer: Stocks discussed here are only for educational purposes and not a recommendation. Please do your research before investing.