Is Quality Systems a Good Buy After Being Upgraded?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, Quality Systems (NASDAQ: QSII) had advanced significantly, up more than 12%, from nearly $20 per share to nearly $22.40 per share in only one trading day. The positive momentum was due to the fact that Baird upgraded the company from neutral to outperform with the target price of $26 per share. According to analyst Eric Coldwell, Quality Systems was trading at a discount now. Should we be bullish about Quality Systems along with the recent upgrade? Let’s find out.

Recurring revenue and a good balance sheet

Quality Systems, incorporated in 1974, is the provider of healthcare information systems in the U.S., operating in four business divisions: the QSI Dental Division, the NextGen Division, the Hospital Solutions Division, and the RCM Services Division. Most of its revenue, $344.3 million – 74.9% of the total revenue – was generated from NextGen, while RCM Services ranked second, accounting for 14% of its total sales in fiscal 2013. NextGen was also the largest operating income contributor, with nearly $121 million in operating income.

Customers of Quality Systems might be familiar with NextGen's products, which include ambulatory products, products that streamline patient care with standardized, real-time clinical and administrative workflows, and NextGen Community Connectivity to exchange patient data within the healthcare organization community. The company believed that the NextGen division would experience good growth, thanks to a strong brand name and an increasing demand for electronic health records. 

What investors might like about the company is its high percentage share of recurring revenue. In fiscal 2013, a combination of maintenance, electronic data-interchange services, revenue-cycle management and other services represented as much as 73.1% of the total sales.

Quality Systems managed to consistently grow its top line in the past five years. Revenue increased from $246 million in fiscal 2009 to $460 million in fiscal 2013. However, the operating income fluctuated in the range of $69 million to $116 million during the same period. In fiscal 2013, its operating income stayed at $69 million. What I like about Quality Systems is its strong balance sheet. As of March 2013, it had $307 million in equity, $118 million in cash and no debt. At $22.40 per share, Quality Systems is worth $1.33 billion on the market. The market values Quality Systems at 10.30 times its trailing EBITDA (earnings before interest, taxes, depreciation and amortization).

Profitable, with high return on invested capital

Compared to its peers, including Allscripts Healthcare Solutions (NASDAQ: MDRX) and McKesson (NYSE: MCK), Quality Systems does not seem to be expensive at its current trading price. Allscripts Healthcare has the highest valuation among the three. The company is trading at $15.50 per share, with the total market cap of $2.7 billion. The market values Allscripts Healthcare at 28.70 times its trailing EBITDA. Allscripts had a quite diverse customer base including 180,000 physicians, 1,500 hospitals,10,000 post-acute facilities and 27,000 individual post-acute providers. Several months ago, the company just bought two health management software businesses, Jardogs and dbMotion. These acquisitions were in the company's plan to refresh its product portfolio and to retain its customers. With these two acquisitions, Allscripts expected to have a low EPS in 2003 but a much higher EPS in 2014.

McKesson has the lowest valuation of the trio. At $118.60 per share, it is worth $26.9 billion on the market. The market values McKesson at nearly 10 times its trailing EBITDA. McKesson generated most of its revenue, $105.5 billion, 86.16% of the total fiscal 2013 revenue, from the U.S. pharmaceutical distribution and services segment. The company reported that it had the market-leading positions, No. 1 and No. 2, in all the markets it serves. Looking forward, McKesson will focus its efforts on the higher-margin and higher-growth business areas to deliver steady growth for the long run. In the period of 2007-2013, it had used around $21 billion, including $8.8 billion in acquisitions, $2.6 billion in internal capital spending, $0.9 billion in dividends and as much as $8.7 billion in share repurchases. For the full year 2014, McKesson expected to generate around $7.90 to $8.20 in 2014 adjusted EPS, with the operating cash flow of $2 billion.

What I like about Quality Systems is its highly profitable operations. Among the three, it enjoyed the highest operating margin and the highest return on invested capital (ROIC). In the past 12 months, the operating margin and ROIC of Quality Systems came in at 19% and 14.2%, respectively. McKesson ranked second with 2% operating margin and 10.3% return on invested capital. The profitability of Allscripts is the lowest among the three, with only 1% in operating margin and -1.59% in ROIC.

My Foolish take

Income investors might like Quality Systems because of its juicy dividend yield at 3.6%. But its payout ratio is quite high, at 97%, meaning that it only retained 3% of its earnings for business reinvestment. Nevertheless, Quality Systems still seems to be a relatively good pick among its peers with the conservative balance sheet, a reasonable valuation and the highest level of profitability. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends McKesson and Quality Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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