Saturday, September 5, 2015

Why I Bought Pacific Healthcare Organization

Pacific Healthcare Organization (PFHO) is a tiny company that handles workers compensation claims in California. It does not provide the funding and therefore is not an insurance company. The company got its start in this business 15 years ago by bringing in Donald Balzano to run Medex Healthcare, the company's main subsidiary. Workers compensation is a business fraught with regulation. And Mr. Balzano is a lawyer with extensive experience in this area. Mr. Balzano is less involved with the PFHO now but he owns 7% of the company. The main owner of the company is Tom Kubota, who owns 60% of the company. The company has a small buy back program which has reduced the float slightly. The company management appears to be only focused on growing the company and not taking advantage of minority shareholders.

Healthcare services companies like this are not exciting investments. They are companies that do labour intensive work and they increase business slowly by building relationships. They typically aren't going to have some breakthrough that will cause revenue to surge. On the other hand, PFHO earnings did take off from 2010 to now mainly because it started from a very small foundation. The company revenue went from $2M to $10M over that time.

The following chart shows the roller coaster ride that shareholders suffered. I think the underlying reason was the surging growth from 2010 to 2014. And when the earnings fell flat in the last twelve months overly optimistic shareholders sold at any price. The company lost some significant "overflow" business and one significant customer. The overflow business was temporary extra work that another company could not handle and the work ended in the first quarter. These things happen. The company will, from time to time, gain customers and lose customers. I don't know and I don't try to predict the company revenue, other than that I don't expect revenue to decrease.

PFHO Stock
I have never used workers compensation nor have I ever thought much about it. So I am learning about works compensation as I go. California has the highest workers compensation expenditures of any state, at 180% of the median. This is understandable to me because California is a egalitarian state with a very wasteful government.

Worker's compensation is a statutory requirement for all employers. But the government is not involved in administration. A company can use an insurance company or self insure. PFHO provides the administration for both types of insurance.

I sincerely believe that health insurance companies and companies that handle other benefits such as workers compensation benefit the user by providing reasonable service with less waste. The government cannot do a better job. Where there is benefit to all there is demand; so these type of companies constitute a growth sector. In fact, in one 10K management said that the greater the regulation and the pressure to cut costs the more these companies will benefit. And California can certainly improve.

PFHO Corvel
Price $ 22.650 $ 30.490
Market Cap $ 18.05 M $ 636.94 M
P/E TTM 9.2 x 22.3 x
Div yield 0.0 % 0.0 %
P/BV 3.30 4.98
Gross Margin28 % 20 %
LT Debt/Equity0.00 0.00
PFHO trades at 9 times earnings. But a year ago it traded at 25 times earnings. It is hard to know what the schizophrenic market is thinking. So I looked at one of its competitors, CorVel Corporation, to get a reference for this type of company. CorVel (CRVL) also exclusively does workers compensation administration. However, it is a nationwide company. Interestingly, I cannot see which states it covers from its 10k. The two companies are similar in many respects. They both have no debt, have growing earnings, pay no dividends and have been buying back shares. But the stark difference is that PFHO trades at 9 times earnings and CRVL trades at 22 times. And PFHO has better margins.

PFHO had a lot of good press on Seeking Alpha last few years. Those articles expound in detail why PFHO is a great investment. So, I feel no need to repeat it here. But the interest is quite exceptional considering the company's market cap. And now unfortunately, I believe the enthusiasm for this stock is disappearing. It is capitulation.

I may be wrong of course. In fact,the stock bumped up a bit on the most recent trading day because management decided to pay a special one-time dividend of $1.25. The money was earmarked for share buybacks but the company cancelled it. Maybe the company felt it was too difficult buying back such a thinly traded stock.

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