Afya - LATAM Stocks Investment Analysis #23

Afya is the largest private medical education company in Brazil.

Dear LATAM Stocks Readers,

This edition will cover Brazil’s largest medical education company, Afya.

Afya has about 10% of all the private medical school seats in Brazil, nearly double its closest competitor. In addition to their core medical school business the company also has a digital services division where they have invested heavily into HealthTech companies, especially via acquisition.

There are a few reasons I wanted to cover Afya:

1.     Several analysts I respect have made a compelling bullish case for Brazilian Education stocks. When I spoke with Fernando Siqueira, the head of research at Brazilian brokerage Guide Investimentos, he highlighted Education as a sector that could perform well in 2024.

2.     Afya is focused entirely on the health education segment, which makes it easier to differentiate and analyze compared to other “generalist” education companies/stocks.

3.     Afya has an ADR that trades outside of Brazil.

4.     On a personal note, my sister-in-law is in the process of applying to medical schools, so I thought I might learn something useful for my family by doing this analysis.

Overall, I think Afya is a solid company, and their business should continue to do well. There are over 5 applicants for every available medical school seat in Brazil, so I expect continued demand for Afya's products.

However, the current valuation is quite expensive. Investors have been willing to pay a premium for the category leader. So I am not as confident that the company’s stock will perform as well as its business.

I hope you like this analysis and learn something about Brazil’s medical and education industries.

As always, comments, questions, and criticisms are welcome in the comments at the end of the write up!

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Common Stock: Afya (Nasdaq: AFYA)

Industry: Medical Education & HealthTech

Current Market Price: $20.08 USD

Market Capitalization: $1.88 Billion USD

*All values in this article are expressed in Brazilian Reais (BRL) unless otherwise noted. The BRL/USD exchange rate at the time of publication is 5-1.

**A complete Disclaimer about LATAM Stocks Investment Overviews can be found by following this link.

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Summary of the Company

Afya is the largest medical education company in Brazil based on the number of private medical school seats. Brazil has roughly 42,000 medical school seats; 10,000 public seats and 32,000 private seats. Afya has 10% of all the private seats in Brazil, which is nearly double its closest competitor. They have 32 campuses spread across 19 Brazilian states.

Management separates Afya’s business into 3 segments:

• Undergraduate: This is by far the company’s most important segment, accounting for roughly 87% of revenue. Undergraduate medical education is Afya’s core business, the company’s other two segments are complementary.

• Continuing Education: This segment includes postgraduate and specialization courses. Continuing education accounts for roughly 5% of total revenue. This is Afya’s smallest segment in terms of revenue, but it’s a low incremental cost complement to their undergraduate segment.

• Digital Services: This segment provides content and technology for medical education, clinical decisions software, practice management tools, electronic medical records, doctor-patient relationship, telemedicine, and digital prescription for physicians. This is the segment where Afya has been most active making acquisitions. Management has built out the digital services segment by acquisition rather than internal development. Digital services accounts for roughly 7% of total revenue.

I won’t go into too much detail about the undergraduate medical school and continuing education segments. I think these are straight forward. I will, however, give a brief overview of Brazil’s medical education system in general later in this write up.

But first I want to talk a bit more about Afya’s Digital Services segments and their aggressive acquisition strategy.

Afya has made significant investments into a wide range of HealthTech companies. Management believes these companies will provide significant cross and up selling opportunities. Afya has a unique opportunity to create long term sticky users of its tech products since it can train medical school students on the use of Afya tech products early in their careers.

Here are a few of the HealthTech companies owned or invested in by Afya:

• Physicians Marketplace: a website that connects doctors and patients to schedule consultations. As of December 3, 2022, the software had almost 23,000 users. The platform is currently used for almost 21 million medical consultations per year, of which around 115,000 were through telemedicine and prescribed more than 6,000,000 electronic medical prescriptions.

• Portal PEBMED: a website that offers free content, including opinions, papers and updates in connection with medical news and scientific publications. PEBMED has more than 200,000 monthly active users on the Whitebook platform and approximately 1.3 million monthly active users to Portal PEBMED.

• Cliquefarma: a healthtech company operating a free-to-use website that tracks prescription drugs, cosmetics, and personal hygiene product prices in Brazil. Users can search for medications or healthcare products and compare prices from over 5,600 pharmacies in Brazil. The traffic generated is monetized through a cost-per-click model, where drugstores pay for each click on their ads, and a cost-per-acquisition model, where drugstores pay for each concluded sale. In 2022, Cliquefarma generated traffic of 21.2 million visitors.

Afya - Business Infographic

Strategy and Acquisitions

A core part of Afya’s strategy is growth and diversification via acquisitions. They have been extremely active in M&A, acquiring 20 companies since August 2019.

I think you can divide the company’s acquisitions into 2 categories:

• Core business growth: Undergraduate medical school is a growth industry in Brazil. The number of seats available continues to grow. Afya wants to dominate this area of the market and grow its market share, so the company has been consolidating undergraduate medical schools via acquisition.

• Diversification: Afya is uniquely positioned in the medical industry value chain. HealthTech is complementary to the company’s core business. It is also a growing niche in and of itself within Brazil’s healthcare industry.

Afya - M&A Timeline

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Brazil’s Medical Education Industry – A Brief Overview

In Brazil, aspiring doctors apply to medical school following graduation from high school. Medical school in Brazil is a six-year undergraduate program. After graduating from the 6 year program medical students gain a license and can start working as a generalist physician. At this point, most consider various continuing education alternatives to gain a certification for one or more medical specialties.

The first and most common path to obtaining a medical specialty certification is through a medical residency program. If a candidate chooses the medical residency path, the student must pass an entrance examination. This exam is administered by each institution offering a residency program. After getting approved by a residency institution, the student then starts the first year of residency. If the physician wants to pursue a sub specialty, they will need additional years of study, which may or may not require additional entrance exams.

Medical professionals that do not choose or fail to be admitted into a residency program can still pursue a medical specialty certification through other alternatives. For example, a generalist can take the specialist certification exam to become a specialist after meeting a variety of eligibility criteria. Those criteria can include internships, hours of work under supervision of a medical specialist, or hours of study in a certified graduate program, among other methods. Depending on the desired level of medical specialty, it can take four to 10 years for a generalist to meet the criteria and, in this context, graduate programs can be a shorter path to reach eligibility sooner.

Typical Medical Career Path in Brazil

Medical School in Brazil is Highly Competitive.

There are over 5 applicants for every medical school seat in Brazil. It’s not hard to understand why it’s so competitive. Doctors are some of the highest paid professionals in Brazil, earning 44% more than engineers and over 200% more than lawyers, on average.

Employability is extremely high for doctors. As far as I can tell, there are very few unemployed doctors Brazil.

Doctor Density

Many of you may be thinking “Of course Doctors are well paid in Brazil, there aren’t enough of them.” But that isn’t entirely true.

Brazil has plenty of doctors, they just aren’t evenly distributed throughout the country.

Brazilian cities with a population greater than 500,000 have 5.3 doctors per 1,000 inhabitants. This is a higher ratio than The U.S., Spain, and The U.K.

Brazilian cities with a population less than 50,000 have less than 1 doctor per 1,000 inhabitants.

This also holds true from a regional perspective. The South, Southeast, and Midwest regions of Brazil all have doctor density ratios comparable with other major economies. The North and Northeast regions on the other hand, have a very low doctor density ratio.

I think it’s important to understand this trend as it will have an impact on where Afya’s growth will come from in the future.

Brazil Doctor Density by Region

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The Financials

Revenue and Cost Analysis

• In the first 9 months of 2023 Afya had revenues of R$ 2.1 billion, a significant increase from R$ 1.7 billion in the same period of 2022.

• Gross margins for the first 9 months of 2023 were 62% compared to 64% in the same period in 2022.

• EBIT was R$596 million in the first 9 months of 2023, up from R$ 517 million over the same period in 2022.

• Net income for the first 9 months of 2023 was R$ 303.5 million representing a profit margin of 14%. Profit margin decreased from 18% over the same period in 2022. Most of this decrease can be attributed to a significant increase in Afya’s financing expenses in 2023.

Balance Sheet Analysis

Afya has a decent balance sheet. Their liquidity position is fine, with enough cash in the short term. Their current ratio is 1.2.

They are leveraged, with a debt-to-equity ratio of 1.2. At first glance this appears reasonable, but 61% of all the company’s assets are intangible, mostly goodwill from acquisitions. If you consider debt to tangible assets, Afya’s is much more leveraged.

Investors should pay close attention to the company’s intangible asset account and watch for any potential impairments.

Debt Analysis

As of Q3 2023 Afya has total debt outstanding of R$ 2.6 billion. This debt has an average duration of 2.2 years and carries an average interest rate of 11.5%.

Afya - Debt Table

Valuation Metrics

• Price to Book – 2.7x

• Price to Sales – 3.5x

• Price to EBITDA - 8.5x

• Price to Net Income – 25.5x

*Based on Last 12 months for the period ending September 30, 2023

Share Dynamics and Capital Structure

As of December 2023, Afya has 93.7 million common shares outstanding: 47.9 million class A shares and 45.8 million class B shares.

• 47.3% of the company is owned by Bertelsmann, a private, German, multinational conglomerate.

• 18% is owned by the Esteves family.

• 4.5% is owned by officers and the company’s treasury.

• 30.3% of the company’s shares free float.

Afya - Cap Table

Dividends & Buybacks

Afya does not pay a dividend. They do have a share repurchase program. From January 1 2022 to September 30, 2023 the company repurchased 2,347,697 shares, which represents 2.5% of the current shares outstanding.

Technical Analysis Notes

There is a very clear horizontal support/resistance line around $17 per share. Afya stock broke out above this resistance line in November 2023.

The stock currently trades above its 200-day moving average and just below its 50-day moving average.

It’s possible there has been a local top and price will be a retest historical support/resistance around $17.

There is reasonable volume, with 500k-1 million shares traded weekly.

I think the technicals tilt bullish.

Afya Stock Price Chart

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Summary and Conclusions

Positives

• Decent financials. Profitable with OK liquidity in the short term.

• Growing its core business as the number of medical school seats grows in Brazil.

• Uniquely positioned as the largest private player in Brazil.

• Digital services are highly complementary and Afya’s unique market position has the potential to help this segment grow.

• Potential increase in students returning from Argentina. Argentina is the most popular destination for Brazilian students studying abroad. It is popular because up until a few months ago, it was free. Argentina’s new president Milei has ended free education for foreigners, so 18,000 Brazilians students (across all disciplines not just med students) in Argentina could potentially be returning to Brazil.

Negatives

• The company has a significant debt burden.

• The medical industry and the education industry are both highly regulated in Brazil. Afya has relevant political risk.

• It is complex to unpack the company’s many acquisitions.

• Valuation looks high at 25x earnings.

Conclusion

Afya presents an interesting investment opportunity. They are the clear market leader in private medical school education and have been able to consolidate the market somewhat. Their digital services business has huge potential long term, but as of today this segment is still mostly a call option on the future.

Their financials are decent. The company is profitable with sufficient liquidity. However the large number of acquisitions, particularly the digital services acquisitions, makes the asset side of the balance sheet hard to unpack.

Long term I think Afya will do well as a business. However at 25x earnings, the market is paying a significant premium to own the industry leader. So while I think Afya's business will continue to grow I am not nearly as confident that investors buying Afya stock at the current valuation will do well.

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Disclaimer

**A complete Disclaimer about LATAM Stocks Investment Overviews can be found by following this link.