May Day and Q&M Dental Group

May is always an interesting month.

As the saying goes, “Sell in May and go away”, this is attributed to the historical under-performance of stocks in the six-month period commencing in May and ending in October. Not surprisingly, the un-realised profits in my portfolio of stocks has almost been halved.

The quarterly earning reports from the companies in my portfolio showed a mixed bag of results. SMRT, SIA, Riverstone, Vicom and Colex were on the upside. Supergroup, Capitaland, Sarine Technologies, Golden Agri were on the downside. Of the latter group, I am slightly disappointed with Super Group’s results. Nevertheless, I took opportunity in the drop in its share price to add to my position in Super Group’s shares (albeit a small amount). The great stock sale is not here yet.

On the upside, the month of May has always been the month when I get a relatively large portion of dividends. So far I have pocketed dividends from Vicom, Sarine Technologies, Colex and Golden Agri. Although I am not a pure dividend investor (eg. I don’t really have very high dividend yield stocks), it is nevertheless good to have dividends. However, I am very far from the point when I can purely survive from my dividend payouts.

Beyond my portfolio, I am taken aback by the explosive upswing of Q&M. Shares of Q & M are now valued at a whopping 77 times the firm’s historical earnings. (read here). I believe at 77 P/E, it must be in bubble territory.

Q&M has been on a buying spree (read here).

As per the old adage: it’s typically cheaper to buy a business than build one from scratch.

Growth At Warp Speed: The biggest benefit of a merger or acquisition is the speed at which it enables one to achieve growth. An acquisition may also enable one to enter new markets quickly and efficiently—both geographic markets and new customer segments.

Risks:

• The risk to this strategy of growth is really whether or not the acquired businesses have ongoing earning power or if the acquirer simply paid a multiple for a ‘one-off’ profit.
• Buying or merging with another company can be an expensive proposition. Frankly I do not know if these acquisitions are at a fair price or has Q&M overpaid for them.  I do not have access to the historical financial reports of Orchard Scotts Dental, De Pacific Dental Group of clinics (located at Ang Mo Kio, Balestier, Jurong West and Pasir Ris),  Tiong Bahru Dental Surgery, Bright Smile Dental Surgery Pte Ltd and Aesthetics Dental Surgery in Park Mall. These are not listed companies and their financials are not accessible to the public. These are unknown territories to most investors.
• In addition, for some of these acquisitions, Q&M  financed or paid for them (at least partially) in stock. This could result in a loss of some control over the business. Neither am I aware of the proportions in shares.
• One of the biggest potential drawbacks of an acquisition has to do with the cultures of the merging companies. Many mergers and acquisitions that made perfect sense on paper have failed miserably due to culture clashes. Would these owner-cum-dentists of these “non-franchise” clinics ever get use to Q&M’s working culture?
• The issue with such fast rate of growth is that the company needs to expand its management capabilities dramatically when it  join forces with another business. All of sudden there is a dramatic increase in employees and assets (to monitor, use & dispose of). Is Q&M’s management able to manage?

When I looked at Q&M’s Financial Statement And Dividend Announcement For The 1st Quarter Ended 31 March 2015 (read here), I noticed the following:

1. Total Comprehensive Income has indeed increased from S$1,515,000 (3 Months ended 31/3/2014) to S$4,634,000 (3 Months ended 31/3/2015 ): almost 2.05 times increase.
2. Total Liabilities increased from S$55,616,000 (as at 31/12/2014 ) to S$106,998,000 (as at 31/3/2015): almost 0.92 times increase.
3. Cash and Cash Equivalents at End of Period increased from S$19,133,000 (as at 31/3/2014) to S$88,494,000 (as at 31/3/2015): almost 3.63 times increase.

The increase in liabilities is still lower than the increase in cash and income, However, since Q&M paid for some of the acquisitions via shares, and one is never sure of potential future  customer and employee attrition nor the post-merger integration costs which are harder to quantify: there is always a big ‘IF’.

The ability to project future growth base on historical financial data is difficult to apply here. Growth here is more inorganic. Although I did not research in detail about Q&M, but while reading past threads on Q&M in Value Buddies, it is highlighted that their services are generally slightly more expensive and that the owners-cum-dentists of these bought over clinics usually leave after the tie-up periods are over (read here). Dentistry, like many other professions depends on the reputation of the dentists (not really product base type of business). So again the future is a big ‘IF’.

The explosive growth of Q&M in recent years has sort of prevented me from knowing the true organic growth of Q&M itself as a practice. Eg. if we take away all these hype and growth via M&A, would Q&M still have good organic growth given the keen competition around it. What is its edge over these competitors?  Its moat so to speak. Reading through its Annual Report, perhaps its moats lie in a strong brand name and scale (the largest network of private dental outlets in Singapore). Nevertheless, has the explosive growth been detrimental (diluted) to the quality of service over time?

So far Q&M has been able to demonstrate strong growth in earnings via M&A activities. And there is really nothing wrong with inorganic growth provided proper due diligence is first done.

However, having said that, at a P/E of 77 (and a 5 yrs EPS growth rate of only 8.38%, EV/EBITDA at a whooping 42.76), it would take a giant leap of faith (for me) to invest in it.