Top 3 EHR Stock Picks

In this episode of Industry Focus: Wildcard, Motley Fool analyst Dylan Lewis and contributor Brian Feroldi bring you three promising electronic health record (EHR) stocks. What does the market look like right now? What are the incentives for doctors and consumers? How are the companies positioning themselves and evolving their strategies.

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This video was recorded Feb. 26, 2020.

Austin Morgan: Hey, everyone, it's Austin, thanks for listening, just want to give you a heads-up that today's show was recorded in late-February, as Dylan is on vacation. So, if there's no mention of the recent news, that's why. Enjoy!

Dylan Lewis: It's Wednesday, March 11^th, time for another Healthcare-focused Wild Card Wednesday. I'm your host Dylan Lewis, and we're stuck with the "just OK" Brian Feroldi. Brian, just becoming a meme at this point; the underwhelming intro.

Brian Feroldi: That would be amazing, if I could become a meme on the internet. And Dylan, I want to start this episode off a little bit differently, because I was at a trivia night at a local bar and we came in first place. And even though we got the final question wrong, we still won out of 12 teams. So, I'm curious, if any of our super-smart listeners know the answer to this ridiculous trivia question, and that is, "Which 19^th century U.S. President was elected to the Senate after his term ended?"

Lewis: And I got to say, you put this in the notes, I have no idea what the answer is. We will reveal the answer at the end of this episode, something for people to marinade on. We're talking about electronic health records. If that's not really your jam, just stick around. Tune out the entire conversation, then stick around for the end and you'll get the answer to that question.

Brian, having you on today to talk e-health and the records management business. Really, a lot of companies that are focused on digitizing and modernizing the way that health records are done. We're doing that because people want some more Healthcare stuff on the Wild Card Wednesday show.

Feroldi: Yeah, and this is a topic that marries two of my favorite industries; tech and healthcare. And I was at my doctor's office a couple of weeks ago; and I just go to a small local physician. And they use electronic health records at their office, and yet, when I walked in the door, they still handed me a pencil and a piece of paper and said, "Here, fill out your name and address and phone number." Even though I've been to the office dozens of times before, so there's still work to do.

Lewis: It sounds like we go to the same doctor. I mean, that's the experience that pretty much everyone seems to be having. And it does seem like we're a little too far along with technology to still be there.

Feroldi: Yeah, exactly. And when you dig into the numbers, the market for IT healthcare products is enormous. I mean, the spending was $280 billion last year. And there are just dozens of ways for investors to play the trend of the gradual digitization of healthcare. I mean, you can go with the IT providers themselves, there's also consultants, there are pure play software companies, there's also software companies that look to healthcare to bolster their growth potential. So, there's huge potential here for investors across the board.

Lewis: And the idea here is a very similar pitch to what you would see with software coming into almost any space. You're getting more efficient, you're avoiding mistakes. In the case of healthcare, you're probably getting better patient outcomes, all the things that hopefully come with more efficient operations.

Feroldi: Yeah. And that's exactly right. And electronic health records, which is a big focus of the show today, EHR, they really just help the healthcare industry tremendously. They hold a huge potential to lower costs. And, as you know, healthcare and regulation go hand-in-hand and there's a big focus around privacy and security of data. So, developing an electronic health record system that is scalable and used everywhere has enormous potential to save the healthcare system huge money in, both, direct and indirect costs in the long-term.

Lewis: We've started to see a lot of offices adopt EHR systems over the last 15 or so years, the adoption has really grown dramatically.

Feroldi: Yes. So, some quick stats on that. So, in 2004, only about 20% of physician offices had any electronic health record system at all in place. But the government has put incentives in place to push the industry to go in that direction. And as of 2018, about 86% of offices had an EHR in place. There are still some holdouts; many of them that are those small offices that haven't made the jump just yet, but the trend is absolutely toward digitization.

Lewis: And you sent me a screenshot of the way that the industry breaks down; just kind of getting a sense of all the different players in the space, and it's pretty fragmented. There are some people that have a pretty big stake, but there are dozens and dozens of companies that play in this industry.

Feroldi: Yeah. I mean, just in the electronic health records industry alone there are dozens of providers. And there's some big companies that have a decent size market share -- we're going to talk of one a little bit later in the show. But there are literally dozens of companies that have developed their own electronic health record system and have had some success in the marketplace. So, this is a hugely fragmented market right now. I could easily see the market continuing to consolidate over time, so that there's a few enormous companies that really dominate and provide interoperability to make sure that health records are easily accessible and portable, but we're not quite there yet.

Lewis: Folks that follow the industry probably know the names Epic Systems and Athenahealth. These are the big giants that are private. We're going to be focusing a little bit more on the public companies in the space, because we want to give people the investable ideas in this industry. One of the first companies that I want to talk about, another pretty big player, is Cerner (CERN).

Feroldi: Yeah. So, Cerner; their ticker symbol is CERN. They are one of the largest providers of IT solutions to the entire healthcare industry. To give you a sense of scale, these guys, 70 of the top 100 health systems are currently users of Cerner's project. They have about a 24% market share of the entire industry, so they are definitely the top dog in the space. And they are a leader in electronic health records and they make it easy for hospitals and providers to share and record data with each other. And they also offer a number of ancillary services to the hospitals and healthcare providers, such as, billing, operational improvements, consulting services.

And their business is actually split -- they make money in a couple of different ways. They make it through professional services as well as licensed software. And this company is in the middle of "wait for it" a SaaS conversion, which we both love. So, their revenue is becoming even more dependable. And they also make money off of support and maintenance contracts. And more recently, they announced a major partnership with Amazon to leverage their AWS services, to bring their technology, to make their platform even better. So, this is the top dog in the space and it's easy to see them remaining so for years to come.

Lewis: You mentioned the SaaS transition. This is something that folks that have heard us talk before, probably know pretty well, but for anyone who hasn't caught those conversations, basically you have a business that is going from the old school model of software licenses sold on a less predictable basis to a as-a-Service model, where you have nice, recurring revenue coming in. The software offering becomes much stickier and much harder for customers to leave. It takes a little bit of time, it's a little painful for businesses to go through that transition, but ultimately, it's a far better business model.

Feroldi: Yeah it takes lumpy software sales and makes them into recurring monthly payments. It works out best for both customers and the providers of the technology themselves. We've seen almost every software company -- I mean, almost every legacy software company switch to a SaaS model over the last ten years, because it's just such a homerun decision.

One downside of the transition is it can temporarily lower companies' reported revenue, because SaaS model pulls in less revenue upfront. So, when we're talking about Cerner's growth rate, you just need to keep that in mind.

Lewis: Yeah. And you mentioned legacy software. This is definitely a little bit of an older business, probably not as high-growth as some of the other software companies that people are used to hearing us talk about, Brian. But with that comes a little bit more stability.

Feroldi: Yeah. This is a company that's been profitable, cashflow positive for years. They've been a terrific long-term investment. So, this is not the most exciting company that we're going to talk about today, but for an investor that's looking for a steady-Eddie business, this is certainly one to checkout.

And just to throw some numbers around there, last quarter this company reported a revenue growth of about 6% to $1.44 billion. They were able to squeeze out some even faster growth on the bottom-line, thanks to some margin enhancements and stock buybacks. So, adjusted earnings grew 23% to $0.49. For the year ahead, for 2020, even with the SaaS kind of dragging them down and some recently, businesses that they decided to exit, they're calling for a low single-digit revenue growth, but they're going to be able to leverage through margin enhancements that into about 15% growth in adjusted EPS.

And this company regularly buys back stock and they also initiated a dividend within the last year. And they pay about a 1% yield.

So, over the longer-term, I think this company should steadily be able to maintain its market share, provide a small boost to the bottom-line that outpace topline growth, and provide double-digit profit growth for the foreseeable future. And on a valuation basis, this company is not priced for hypergrowth by any sense. They're trading for about 20X next year's earnings. And again, they do come with a small dividend. So, if you're looking for a slow-moving way to profit from this trend, I think Cerner is a great choice.

Lewis: Yeah. I think that TL;DR on Cerner is, legacy business that's going through the tough part of becoming a SaaS company, but they have a really steady, solid business backing that transition up. And they give you the return to shareholder type capital allocation decisions that a lot of people love; the stock buybacks and the dividends, nothing wrong with that.

Feroldi: Yeah, totally. So, this is a great stock for low-risk investors to check out.

Lewis: Our second stock is one that I know quite well, because I'm a shareholder, and that is DocuSign (DOCU -0.26%). This is a stock that has really rewarded shareholders over the last year-and-a-half or so.

Feroldi: Yeah. So, DocuSign, we talked about on the show before, mostly on the Tech show. And they're a leader in electronic signature. So, anytime you electronically sign your name, DocuSign is the brand that has the dominant market share. And you and I did a deep dive on this show, after it came public in 2018. And we both gave it the thumbs up, and I think we both became shareholders right away. And shares have just gone on to produce great returns, I mean, they're talking about more than double since 2018.

And the reason I wanted to highlight it for healthcare investors is, DocuSign is obviously not a pure play on healthcare IT, but this company is placing an emphasis on using their services within the healthcare market and they are starting to see some traction. More than 100 hospitals are actually currently using DocuSign's products for all kinds of reasons for patient intake, physician credentialing, hiring on their own side, HIPPA compliance.

And DocuSign is also focusing on the health plans, as a way to get them to connect better with their members. So, they have UnitedHealthcare [UnitedHealth Group,] which is the largest health plan in the United States is a DocuSign customer, as is Anthem Blue Cross and Blue Shield, WellCare, Kaiser Permanente.

And DocuSign also has been going after the global life sciences businesses to partner with drug developers, because there's huge compliance and signing for things when you're running clinical trials. And these guys have already landed 18 of the top 20 global pharmacy company. So, healthcare is definitely a growth industry for DocuSign.

Lewis: If you look at what they're doing in healthcare too, I think what you see is a very similar roadmap to what they've done with other industries, namely, the financial industry. They have some big deals inked with some of the major players in that space. And that's just going to create a ton of volume for them and is going to get them entrenched with the players that really shape the industry. I mean, I know so many people that have gone through the mortgage process and used DocuSign here at The Fool. And so, I think they're very smart in, who they're working with, who they're partnering with and really getting themselves out there. I they're kind of the go-to name when it comes to the electronic signature and document management process.

Feroldi: Yeah, exactly. And you think about healthcare, even as a patient, how many times you have to sign your name, when you check in, when you fill out your HIPPA compliance form, when you're filling out your beneficiaries, I mean, there's dozens of times that you have to sign your name related to healthcare. So, DocuSign naturally plays right into that. And as we alluded to previously, this is a company that is just getting it done. I mean, they are producing fantastic growth numbers.

So, last quarter, this company added 25,000 new customers. And that brought their total up to 560,000 total customers. So, that kind of growth is just driving a strong growth in the topline. We saw 40% growth in the topline to $250 million. It's a software company, so they produce great gross margins of 75%. They are still producing GAAP net losses, but if you adjust for that, they are profitable on an adjusted basis. And one of the key metrics that we always look for in any Software-as-a-Service company is dollar-based net expansion rate, which is a measure of same customer spending from period-to-period. This company just recently produced 117%, which means that even if they weren't adding any customers at all, the top-line would have grown 17%. So, really, when you look at this company's numbers, there's just so much to like.

Lewis: Yeah. One of the other things that I really like too, is they have this deepening relationship with Salesforce.com. And we talked about how they very smartly approach the healthcare industry and the financial industry. I think, being in Salesforce's good favors or being on their good side is probably a good thing if you're a software company, because they have such outsized influence in this industry, particularly with enterprise clients.

Feroldi: Yeah. Salesforce is a major player, and by deepening their relationship with them, DocuSign is actually helping with contract lifecycle management as well as the entire negotiation process. So, the combination of Salesforce and DocuSign is helping with negotiations in the background to really automate that process as much as possible.

So, when we first talked about them on the show, we talked about how DocuSign sees a total addressable market opportunity of about $25 billion, management believes that their recent integrations and new products that they've launched has the potential to double that in time. So, this company is still deeply underpenetrated with its long-term potential. And although it's not, by any means, a healthcare pure play on the IT front, it's definitely an accelerator. So, this is definitely a stock that growth-focused investors should get to know.

Lewis: Alright, let's switch gears and talk about our third stock. This is one that I had to check on the pronunciation of, and a little bit out of my element here, this is Phreesia (PHR 0.73%), ticker PHR, another Software-as-a-Service company.

Feroldi: Yeah. And these guys, if you're looking for a pure play on healthcare IT, that's exactly what Phreesia does. And this company is hyper-focused on the patient intake process, so that includes registration, scheduling, checking-in, bill pay, anything that a patient would experience when they're interacting with a healthcare office. So, Phreesia partners with healthcare providers, and they have a mobile app that patients can use to sign-in and schedule the appointments, as well as there's also a tablet, an iPad-like device, that Phreesia puts into some offices that patients can use when they walk-in to electronically sign-in. And this just greatly speeds up the check-in process and scheduling new appointments. I wish that my healthcare provider would adopt Phreesia's technology, because it just sounds so much better than what I'm doing now.

Lewis: Yeah, Brian, I mean this is solving the exact pain point that we were talking about at the beginning of the show.

Feroldi: Yeah, exactly. And Phreesia, as we talked about, is really focused on patient intake, but they also have direct integrations of their product with dozens of other electronic health record companies. So, they have partnerships with Cerner, Meditech, Athenahealth, Allscripts, they partner with payors, they partner with payment networks. So, they are on the frontend, and that's what their specialty is, but their fingers do extend out to other companies.

And this is a company that actually has currently has three sources of recurring revenue, all of which are growing. So, the first is healthcare providers pay them a subscription fee to just offer the service at their office, but whenever a patient makes a payment on its platform -- so, for copays or deductibles -- Phreesia also gets a portion of that sales. And then, lastly, they actually partner with life sciences companies -- so, medical devices, drug developers -- to provide targeted digital marketing services. So, this company has numerous ways that it's monetizing its user base. And that's something that excites me as an investor.

Lewis: Yeah. And they're all kind of slightly playing in different elements of the healthcare home office and these things that really businesses need to be able to do. I like that they have an arm in payment processing, in particular, because it gets them a little outside of just the core operational elements of healthcare. They already have a pretty decent book of clients and provider organizations.

Feroldi: Yeah. So, they've already signed up about 50,000 healthcare providers already. Management believes that their addressable market opportunity, just in the U.S., is about 900,000 offices, so there's still plenty of room to go. And independent, third-party reviewers have rated Phreesia's software and service as the top choice for patient intake management. So, that certainly gives this company a nod from a third-party. And that could help them, in time, to continue to grow within their target market.

And this company is pulling in about $100 million in annualized revenue and last year that grew at about 25%. Management seems to think that its total addressable market opportunity is about $7 billion. That might be a little bit aggressive given what we know about how companies like to talk up that number, but I do think it shows that this company has a nice niche for itself and it is growing.

Lewis: To your point about them being best-in-class too, that's the kind of thing that gives a software provider some pricing power. If you are able to be the one-stop-shop and really the best solution for someone in a space, especially a smaller space where there aren't going to be nearly as many software providers, then you're able to demonstrate your value, and over time, either upsell folks or slowly increase prices to reflect the better service that they're getting.

Feroldi: Yeah. So, I think Phreesia is so hyper-focused on the intake process, that they can make that process as seamless as possible for patients. And that's I think a defendable market. I mean, there's lots of other companies, even like Cerner, as we talked about at the top of the show that provide these kind of services, but because Phreesia is hyper-focused on just the intake and it offers integration with Cerner for a whole bunch of other processes, there is a reason that some healthcare providers can choose to work with one or even more of these companies at just one time. So, this isn't a market where there's just going to be one solution necessarily, there could be multiple solutions, even within a single office.

Lewis: If Cerner was your too boring, too mellow, and maybe DocuSign was you're too aggressive, too growth-oriented, this could be the just right stock of the three for some folks that are looking for something a little bit in the middle. A 19% revenue growth next year and they're currently trading at about 10X sales. So, not nearly as aggressive a valuation as what we saw with DocuSign, but more impressive growth rates than what we're seeing with Cerner.

Feroldi: Yeah. And the company has reached enough scale to start showing adjusted net income, at least on an EBITDA basis, which always needs some context. On a GAAP basis, they are still showing net losses, but that's very common for fast-growing Software-as-a-Service companies. One thing I did want to call out is this company does have some customer concentration issues that investors need to be aware of. So, their top four clients comprised about 19% of sales last year, that should continue to fall and become less of an issue over time, if this business can continue to grow, but that is something that, I think, investors do need to know ahead of time.

Lewis: Alright, Brian, we threw out three stocks. I have to ask you at the end of the show, which one is your favorite play on the space?

Feroldi: I think you know the answer to that, and that's going to be a DocuSign. I mean it's hard for me -- DocuSign has become one of my personal biggest holdings, just because of the outstanding performance and the strong growth. And I think it's just growing its customer count so good. And I like that healthcare is an accelerator of its growth, it's not completely dependent on healthcare for growth. So, of the three, it's definitely my favorite choice. How about you?

Lewis: I'm right there with you. I mean, you know, it's my kid, I own it in my brokerage account. [laughs] How can I vote against it? It's a great business and it is in so many industries, and just really making things so much easier. And the stock has performed so well; I only expect that to continue. I think that the tailwinds there are just so strong.

Before we wrap up, Brian, we threw a trivia question out there at the beginning of the show. We got to give people the answer.

Feroldi: Yeah. So, again, the question was, "Which 19^th century U.S. President was elected to the Senate after his term as President ended?" And the answer is, Andrew Johnson. So, congratulations, if you knew that. You should come be on my trivia team.

Lewis: Yeah, I mean, those should be the folks living in Washington D.C., not me, because they clearly have a better sense of the nation's history.

As we wrap up, listeners know that, if folks give us a five-star review, I'll give it a shout-out on the air. We have one from JPort, who writes in, "Thanks so much for bringing Healthcare back." Look at that, Brian, reading it on a show we're doing on healthcare right now. "Love the new intro. Thanks for all the great content you bring, and thanks for keeping me company when I walk the dog at nights and on my morning commute."

Love it. Love to know where people are listening to our shows and where we're going into their ears and hopefully make them smarter, happier and richer. Brian, thanks again, for hopping on today's show.

Feroldi: Anytime, Dylan.

Lewis: Alright. Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say "Hey!" shoot us an email over at [email protected] or you can tweet us @MFIndustryFocus. If you want more stuff, subscribe on iTunes or wherever you get your podcasts.

And as always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Dan Boyd for all his work behind the glass today. For Brian Feroldi, I'm Dylan Lewis, thanks for listening and Fool on!