The Q3 report reflects consistent performance in our view, showcasing the desired indicators. Margin expansion, stemming from effective cost management, growth in Wellness subscription revenues, and a 12% year-on-year increase in ARR, are notable highlights. Furthermore, there was a positive quarter-on-quarter improvement in cash flow. Nevertheless, the strategic emphasis on higher-margin customers led to a top-line that was slightly softer than expected. However, we contend that we prefer a restrained top-line with margin expansions over a strategy focused solely on pursuing growth at any cost. Year-to-date, the organic growth stands at 27%, surpassing the 17% median of its peer group for 2023e. Our optimistic outlook on the company persists, and we anticipate that new contracts for Champion Health will contribute to continued growth in the Wellness division during Q4 and 2024.

Physitrack reported Q3’23 sales of EUR3.9m, 14% y/y growth and 5% below our estimate. When excluding negative FX effects, organic sales grew by 17% y/y. Further, sales increased by 4% on a q/q basis, an improvement from last quarter when sales q/q were close to flat. Organic growth was derived from both the Lifecare and Wellness divisions, which grew 11% and 29%, respectively, y/y.

Looking at revenue generation per segment, Lifecare subscription remains the main contributor, generating c54% of the revenues. Wellness subscription is now on par with Wellness one-off, representing 19% of the revenues respectively. Previously, we emphasised the importance of monitoring the growth of subscription revenues within the Wellness division as a crucial key performance indicator (KPI). The rationale is straightforward: this growth is integral to determining the division's success and facilitating overall margin expansion for the division and the group. In Q3’23, Wellness subscriptions amounted to EUR0.7m, reflecting a 20% quarter-on-quarter growth and comprising c50% of the total revenues in the Wellness division. Lifecares subscription share of revenues increased to c90% during the quarter.

Recurring revenues grew c16% y/y, representing 75% of total revenues. On a q/q basis, recurring revenues grew by 9%.

The Annual Recurring Revenue (ARR) experienced a 12% year-on-year (y/y) growth and a 3% quarter-on-quarter (q/q) increase, reaching a total of EUR11.8 million. The rapid y/y increase in recurring revenues/ARR suggests that the Wellness division is progressing toward harmonisation and standardisation.

Adjusted EBITDA (adjusted for EUR0.2m in acquisition and integration costs) reached cEUR1.1m in the quarter, corresponding to an EBITDA margin of 27% (27%), 1pp below our estimate. Operating expenses (OPEX) came in slightly lower than estimated, compensating for the marginally weaker top-line performance. Adjusted EBITDA YTD came in at 6% in the Wellness division, an improvement from last quarter, where the figure was 4%.

Cash flow from operating activities before payments of adjusting items was EUR0.9m (EUR0.7m), whereas the Free cash flow was – EUR0.3m, an improvement of EUR0.3m q/q. By the end of Q3’23, Physitrack held a EUR0.4m cash position, but the available liquidity, including the Revolving Credit Facility (RCF) corresponds to EUR2.3m. Management re-confirms “that it is expected there will be no further deferred contingent consideration payments for the remainder of the financial year, and no capital raising via share issuance or debt.” During the conference call, the management also confirmed that the current liquidity is sufficient to cover all organic expenses in the future. However, the CEO left the door open for capital raises via equity or debt if/when Physitrack decides to open up its M&A program again.

For Q3’23, we estimate that Physitrack capitalised EUR0.9m for development, implying that adjusted EBITDA minus capitalisations amounted to EUR0.2m.

Management remains confident that the business will be FCF positive by the end of the year. Physitrack defines free cash flow as net cash from operating activities, less purchase of intangible assets and property, plant and equipment and finance costs.
Physitrack’s net debt was cEUR3.3m by the end of the quarter.

Champion Health secured significant contracts during the quarter, including a multi-year deal with E.ON and a contract with Healix. We anticipate that these agreements will contribute to the growth within the wellness subscription segment in Q4’23 and drive further margin expansion as we advance.

In the conference call, management provided updates on both the Lifecare and Champion Health platforms. The ongoing and upcoming enhancements result from an accelerated focus on product and content development leveraging AI. We anticipate that utilising AI for translation and local content adaptations can contribute to a more cost-effective market expansion.

Q4 appears to be commencing on a positive note, particularly within the Wellness division and Champion Health. Numerous significant enterprise re-tenders from the COVID-19 era are now open, and management expresses optimism about their chances of securing some of these opportunities.

Further, management underscores their dedication to achieving profitable growth, signalling their willingness to decline customers failing to meet margin or payment cycle thresholds. We infer that the tightening of payment cycles is partly driven by the need to alleviate working capital constraints.

Substantial improvements have been made to the current Champion Health platform, including streamlining user interface performance enhancements and introducing new features to elevate the overall user experience. According to the company, the platform is now well-prepared for localisation and expansion into non-English speaking territories. However, we expect a US launch via the Healix agreement to be just around the corner.

The report reaffirmed the financial midterm targets, which encompass a 30% year-on-year organic growth coupled with EBITDA margins ranging from 40% to 45%. Furthermore, management is confident in achieving positive Free Cash Flow (FCF) in Q4’23. During the conference call, the CEO, Henrik Molin, expressed that the company might start providing more short-term guidance in addition to their midterm targets (3-4 years) and that we can expect an EBITDA margin of 30-35% within the Wellness division over time (currently at 6% YTD). Certainly, we advocate for more precise guidance and believe that some of the declines in the share value following the Q3 report could have been mitigated with more tightly defined guidance. It appears that the market is somewhat assessing the quarterly performance in relation to the midterm yearly targets.

We have made minor adjustments to our near-term estimates following Physitrack’s Q3 report:

We expect Physitrack’s cash position combined with the RCF to be enough to reach positive cash flows and the RCF and FCF to cover further earn-outs. Nevertheless, our estimates allow for a little margin of error. Relative to Physitrack's midterm-term targets of 40-45% EBITDA margin and 30% organic growth, we have adopted a more conservative stance regarding growth and margins in the midterm perspective. For further estimates, see the tables below.

Due to rising interest rates, we have raised the risk-free rate from 2.5% to 3.0%, resulting in a WACC of 12.5% (12.0%). Our Base case is now at SEK38 (SEK41) per share due to a higher WACC and estimate adjustments. Our fair value range is adjusted to SEK12-SEK76 per share (previously: SEK12-SEK80). Currently, Physitrack is trading at an EV/EBIT multiple of 8.5x and EV/Sales 3.8x based on our 2024e. Our valuation is based on the financial forecasts in the table above (Base case) and long-term assumptions outlined in the table below.

Compared to its peers, median EV/Sales multiples for 2023e–2024e, Physitrack trades at a 35%-45% discount. Moreover, the discount is also prominent when comparing median EV/EBIT multiples for 2024e, with Physitrack trading at a c45% discount to its peers. Despite the management’s guidance, we believe the market continues to worry over the cash flow capital infusion need.