Fonar Corp (FONR): cheap with high earnings quality and room for improvement
The information for this article mainly comes from the annual report (30 June 2023), the quarterly report for the quarter ending on 31 December 2023 and the proxy filing for the annual meeting on 20 May 2024.
Fonar Corporation manufactures and maintains MRI scanners and also provides “management services, including development, administration, accounting, billing and collection services, together with office space, medical equipment, supplies and non-medical personnel to its clients.” The latter business segment is profitable while manufacturing MRI scanners is a bleeder.
The stock is listed on the Nasdaq with ticker FONR. I own this stock because this is a low EV/EBIT stock with many metrics suggesting great earnings quality. The company is also small: At $15.24 per share the market cap is $102 million and the enterprise value is $40 million. Currently EV/EBIT is equal to 2.3. The stock is also cheap based on EV/Revenue.
These non-medical services are provided through the HCMA subsidiary. HCMA also has 6 subsidiaries in Florida that also provide medical services. In total HCMA owns or manages 27 facilities. In financial year 2023 12% of the revenue was from three other facilities in Florida owned by the CEO, who is the son of the now deceased founder.
During the last 5 years the company spent $8.5 million on research and development. The company uses patents to protect its intellectual property. In the annual report the company mentions it is awaiting the outcome of 8 pending patent applications. I do not think the company owns significant intellectual property.
The balance sheet is strong with low leverage, a high current ratio, lots of cash, no significant debts but instead some lease liabilities. These liabilities are mostly current and together less than the cash balance.
I estimate the stock is almost 7% more expensive than it seems to most investors because of unlisted shares. The CEO and chairman, Timothy R. Damadian, has almost all C-shares with 25 votes per share (red flag). Because of the extra votes he is the controlling shareholder. But the C-shares have only a third of the economic rights of a common share. His shares (C-shares, A-prefs and commons) are currently worth at least 4 million USD. His economic ownership as a percentage of the total share count is very low.
The company does not pay any dividends, maybe because dividend payments on the commons are three times those on the C-shares. Instead, the company is repurchasing shares. While spendings on repurchases are significant these efforts are still pretty minimal in terms of share count reduction.
That the CEO is also the chairman is a red flag. Not good either is that he is also Treasurer. This company is large enough for a separate chairman and a separate “Treasurer”. I have not found a name for the CFO so I suppose the “Treasurer” is the CFO. I think however the reason for this mix of functions is that this company is frugal.
In addition one of the three independent directors is already 12 years a director. After such a long time he might not be independent enough. Another, non-indepent director is already 86. At that age most people do not have enough energy to do a proper job as a director.
The CEO/chairman did not get a salary in 2021, 2022 and 2023. He did get a bonus in each of these three years. I would call his compensation and compensation of the other executive officer very modest, especially for an American company. That there are only two executive officers and that the board is small (5 people) is a good sign.
A couple of years ago the CEO got 24k USD per month for providing billing services through another company controlled by him. He sold his stake in the billing services company in May 2023, when the contract with Fonar also was terminated. Before 2021 he also got 85k USD per month for providing some other billing services. I think interests of the controlling shareholder are now more aligned with the interests of other shareholders of Fonar Corp than in 2022 and even more so than before 2021.
The are two quantitative funds/passive investors in the stock: Dimensional Fund Advisors and Vanguard Group. I believe active investors are Kayne Anderson Rudnick Investment Management LLC with almost 10% and Money Concepts Capital Corp with slightly more than 5%. The other executive officer, the Vice President, owns for more than 800k USD in shares. The other directors do not own substantial wealth in shares.
My take: Cheap business based on EV/EBIT, EV/Revenue with excellent quality metrics. Well managed, but the business can be improved by divesting or liquidating the MRI scanning designing and manufacturing business.
What I do not like is the dual share class structure, the balance sheet with too much cash and that the company does not pay out much to shareholders.
The CEO is the son of the founder, who died. With the new controlling shareholder I think we are seeing some changes such as small repurchases. The CEO and controlling shareholder has an incentive to do repurchases instead of paying dividends because dividends on his shares are much lower.
I won this stock and I think this is a good stock for a small position.
On Twitter someone commented that the stock is also less cheap than it seems because of earnings that go to minority interest. After correcting EBIT for this effect (excluding part of EBIT based on net income attributed to minority interest) EV/EBIT is low enough for it to be an excellent low EV/EBIT + quality, on a statistical basis.
Enjoyed this write-up. Thumbs up!