Boring Portfolio

Boring Portfolio Report
Thursday, December 18, 1997
by Mark Weaver, MD (mweav@aol.com)


St. Louis, MO (Dec. 18, 1997) - It was another forgettable market day as concerns about the economic situation in Asia continued to weigh on investors. The fact that tomorrow is triple-witching day when both options and futures expire probably contributed to the volatility.

In addition word out of the Philadelphia Federal Reserve indicating a sharp drop in their business-activity index didn't help matters either. Fears of declining profits put coal in the stocking of stockholders while bond bulls were sipping egg nog. The long bond yield is down to 5.93%.

As for the stock market, the S&P 500 dropped 1.06% while the tech heavy Nasdaq Composite dropped 1.56%. The Naz has been hit with a particularly hard case of the Asian flu. In the meantime the Borefolio was off 1.07% in line with the S&P.

There was no news whatsoever on any of the Borefolio holdings. However, there are a couple of items worth mentioning. First of all, Felcor Suite Hotels (NYSE: FCH) was the subject of a comprehensive post by TMF Yorick, the head Fool over on the Real Estate board, you can click on over and see what he has to say about our favorite REIT.

The latest issue of Forbes crossed my desk today and REITS are the featured topic. The headline included these words "Forget industrial stocks. For the next few years real estate is where the action will be." We are happy with our Felcor holding. Felcor was up $1/8 today.

Speaking of Forbes, you may recall that the last issue featured the problems with analyst earnings estimates. Green Tree Financial (NYSE: GNT) was one of the featured companies and the Oppenheimer analyst who "called the shot" was featured as well. This analyst has issued a new report and Greg Markus is tracking down the details. Expect a report from him tomorrow. In the meantime, Green Tree was up $1/16 today.

Our biggest loser was Tidewater (NYSE: TDW) which fell $1 3/8 in spite of a gain in oil prices. Although the business of Tidewater is boring enough, the stock moves more like the tides in the Bay of Fundy which are decidedly unboring.

As part of our continuing review of the Borefolio holdings I took on Prime Medical (Nasdaq: PMSI) this week. So, count this as my 'State of the Prime' address.

Prime Medical entered the Borefolio in March of 1996 at $10.07. The stock was a big early winner but then fell on hard times, from which it has been recovering gradually. What happened was that in mid-1996, Prime floated a stock offering to help finance a large acquisition, one which doubled the size of company virtually overnight. Unfortunately, the timing of that offering coincided with the summer meltdown of small-cap stocks. As the share price tumbled, Prime decided to cancel the stock offering and finance the acquisition through debt instead.

Through it all, the company has consistently either achieved or exceeded earnings estimates. Yet the stock has been a real Rodney Dangerfield: it got no respect -- at least not until the past few months or so.

As part of my review, I phoned Prime's chief financial officer, Cheryl Williams, to get her take on the how the company is doing. As has been our experience in prior conversations, Williams was more than willing to field my questions.

She reported that lithotripsy operations are meeting expectations. I asked her about any further acquisitions and she told me that a few opportunities were being explored but that nothing was close to fruition. These days, Prime is focusing on ramping up its new prostate thermotherapy business.

On that front, the North Carolina Prostatron route is operational, and the physicians using the unit have been pleased with the results. Due to delays related to training physicians and inking hospital contracts, however, the ramp up in procedures has been somewhat slower than had been anticipated. The company has a second Prostatron route finalized in California, and there are an additional seven or eight partnerships in various stages of development.

I asked Williams why Prime Medical was undervalued relative to its peers. She said that she, and others, remain baffled by the market's tepid response to the company's results. In her opinion, the stock deserves a higher price.

On a P/E to earnings growth (PEG) basis, the stock appears to merit a higher multiple. PMSI currently trades at 15.6 times next year's estimates, a below-market ratio. The PEG is 0.68, which implies the stock deserves a price of around $19.

I then booted up my Morningstar Stock Tools to see how the company matched up to its peers. I was trying to determine whether the problem at Prime was company-specific or related to concerns in the healthcare business more generally.

I found that, according to the database, Prime Medical is trading at 17 times trailing earnings, 2.9 times book value, a price/sales ratio (PSR) of 2.8, and at only 6.9 times cash flow. Of those four variables, only the price/sales ratio was above the industry average. Most notably, the price/cash flow ratio was only 43% of the health services industry average.

Looking more closely at the companies being used as "comparables" in the database, I found that many of them weren't truly all that comparable to Prime Medical, so I went through the list and selected several stocks of companies that provided radiology services, cardiac catheterization services, physician management, or dialysis services. My thinking was that these companies should reflect the current climate for Prime in terms of Medicare reimbursement and managed care concerns.

This narrowed the list of comparables to six companies: US Diagnostic Laboratories (Nasdaq: USDL), Diagnostic Health Services (Nasdaq: DHSM), Innoserv Technologies (Nasdaq: ISER), MedCath (Nasdaq: MCTH), Physician Reliance Network (Nasdaq: PHYN), and Renal Treatment Centers (NYSE: RXT)

Prime is trading at the lowest trailing P/E of the six stocks. Three of the companies sported operating losses, and the others were trading above the health services industry average. PMSI trades at a higher price/book than its peers and also at a PSR that is higher than five of the six stocks.

Looking at the price/cash flow ratio, Prime Medical is the clear winner. At 43% of the industry average, PMSI is priced more attractively than all six comparables. And at 6.9 times cash flow and only 7.3 times free cash flow, the company is clearly in bargain territory.

So, what do I make of all of this?

Reflecting on my recap last week, in which I reviewed Peter Lynch's criteria for investing in a stock, Prime comes out looking pretty good. First, despite all the medical mumbo-jumbo, the company's basic "story" is readily understandable: it is consolidating the lithotripsy business and then leveraging that relationship with urologists to expand into Prostatron therapy for prostatic disease and also into related urology management services. This is a sound business plan to these eyes.

Second, the stock is trading below its historical P/E, below the industry average P/E, and with a PEG of less than 1.0. The balance sheet is in reasonably good shape, although some might quibble with the debt load at 50% of market capitalization.

I also looked to see which mutual funds hold Prime Medical shares. According to Morningstar, the average rating of the funds holding Prime Medical stock is 3.8 stars, with several 4 and 5-star funds listed as owners. This tells me that some of the better mutual fund managers also see value in Prime Medical.

My current reading is a book by Ralph Wanger, the manager of the highly successful Acorn Fund. The book's title is A Zebra in Lion Country. In it, Wanger discusses small-cap investing. Early in the book, he writes about the problem of the languishing small-cap stock and the non-recognition of the true value of the stock by the market place. He writes, "In our experience, there is no reason to worry about nonrecognition: the sound economic values of good small companies get reflected in their stock prices sooner or later."

When I look at Prime Medical, I see sound economic values. And I am willing to wait for the market to catch up to my thinking. Prime's stock closed unchanged today at $13 1/8.

--Mark Weaver, MD

Do your Foolish gift shopping now, in time for the Holidays. And consider the Fool's Industry Focus '98 book -- to learn not only about industry-leading stocks, but about the industries in which they operate as a whole -- and see which one company in each industry that our news and analysis team favors most.


TODAY'S NUMBERS
Stock  Change    Bid
CGO   -1 1/16  24.44
BGP   -  11/16 30.06
CSL   -  1/4   43.38
CSCO  -  9/16  53.56
FCH   +  1/8   37.75
GNT   +  1/16  24.56
PMSI    ---    13.13
TDW   -1 3/8   55.13

                   Day   Month    Year  History
        BORING   -1.07%  -4.49%   7.85%  24.10%
        S&P:     -1.06%  -2.00%  28.97%  53.68%
        NASDAQ:  -1.56%  -6.59%  17.98%  46.33%

    Rec'd   #  Security     In At       Now    Change
  2/28/96  400 Borders Gr    11.26     30.06   167.07%
  8/13/96  200 Carlisle C    26.32     43.38    64.77%
  6/26/96  150 Cisco Syst    35.93     53.56    49.06%
   3/8/96  400 Prime Medi    10.07     13.13    30.35%
 12/23/96  100 Tidewater     46.52     55.13    18.48%
   3/5/97  150 Atlas Air     23.06     24.44     5.98%
  11/6/97  200 FelCor Sui    37.59     37.75     0.43%
   2/2/96  200 Green Tree    30.39     24.56   -19.17%

    Rec'd   #  Security     In At     Value    Change
  2/28/96  400 Borders Gr  4502.49  12025.00  $7522.51
  8/13/96  200 Carlisle C  5264.99   8675.00  $3410.01
  6/26/96  150 Cisco Syst  5389.99   8034.38  $2644.39
   3/8/96  400 Prime Medi  4027.49   5250.00  $1222.51
 12/23/96  100 Tidewater   4652.49   5512.50   $860.01
   3/5/97  150 Atlas Air   3458.74   3665.63   $206.89
  11/6/97  200 FelCor Sui  7518.00   7550.00    $32.00
   2/2/96  200 Green Tree  6077.49   4912.50 -$1164.99

                             CASH   $6427.47
                            TOTAL  $62052.47