Pro Medicus (ASX: PME) won a contract with UCHealth of at least $170 million over 10 years, marking its second-largest contract, roughly half the size of its largest with Trinity Health. UCHealth has 14 hospitals in three US states, including its most advanced hospital, the University of Colorado Hospital.

Why it matters: Pro Medicus is accruing contracted revenue slightly faster than our expectations in the key existing academic hospital market. Our revenue forecasts over the next 10 years increase by an average of 3% on this basis, partially offset by a weaker US dollar.

  • We assume a two-month earnings contribution in fiscal 2026. The full-year contracted revenue makes up 6% of our total revised fiscal 2027 revenue forecast of $347 million from $325 million prior. While we had previously expected further contract wins, UCHealth is abnormally large.
  • We maintain our midcycle 77% EBIT margin assumption by fiscal 2034 from our estimate of 73% in fiscal 2025. While we expect operating leverage, we think the research and development spending required to stay competitive long-term will limit margin expansion.

The bottom line: We raise our fair value estimate for narrow-moat Pro Medicus by 5% to $50. Shares are materially overvalued with unrealistic growth expectations baked in based on the size of the key addressable market. Shares currently trade at 175 times our forecast fiscal 2027 EPS.

  • While some smaller hospitals pay a premium for Pro Medicus’ software, we expect wider uptake to be slow. Visage 7 resonates most with US academic hospitals that have an interest in advanced visualizations. We think most hospitals don’t require the best technology on the market.
  • We would have to assume a midcycle EBIT margin of 90% and a 10-year revenue compound annual growth rate of 37% to justify the share price, versus our current 77% and 13% forecasts, respectively, and we think this is unlikely.

Pro Medicus’ business model ss sound, but shares screen as expensive

Pro Medicus’ strategy revolves around renewing existing contracts and winning new clients for its main product, Visage 7, while increasing its price point. The company won six out of six major public tenders it competed for in fiscal 2021, which often involved on-site pilot tests. While this likely highlights Visage 7’s current superior speed, scalability, and resilience, continued investment in research and development is imperative for the firm to remain at the forefront of innovation and consistently win contracts. Most of the firm’s expenses are allocated to over 40 software engineers with the main R&D center located in Berlin. The company also recently extended its R&D capability in New York in collaboration with NYU Langone Health in 2021. Its R&D efforts mostly revolve around software enhancements, program extensions, and research in artificial intelligence to assist in diagnoses.

Many of Pro Medicus’ competitors already utilize server-side rendering and cloud-native architecture. Legacy systems are also mostly owned by larger competitors such as GE Healthcare, Fujifilm, and Philips, which will be incentivized by the high returns in the industry. In Australia, Sectra won an AUD 85 million 13-year deal over Pro Medicus with NSW Health for both its Radiology Information System and Picture Archiving Communications System in 2020.

Visage 7 has found most success with US academic hospitals and in fiscal 2022 was in nine out of the top 20 ranked US hospitals, more than double its nearest competitor. While Pro Medicus has secured a few contracts with midmarket US hospitals such as Allegheny and Wellspan, wider uptake has been slow, with Visage 7’s features likely superfluous for their normal operations. However, Pro Medicus is still targeting smaller radiology groups that seek to consolidate IT infrastructure and become more efficient.

Currently, Visage 7 is limited to radiology departments, but Pro Medicus is aiming to extend the product set to other specialty departments, including cardiology and ophthalmology. In addition, when winning contracts, the firm has other product offerings, such as Open Archive or Visage RIS, that it can cross-sell to clients.

Bulls say

  • Pro Medicus is well positioned to benefit from industry tailwinds such as cloud adoption, larger datasets, and remote access.
  • Earnings are extremely defensive due to contracted revenue being largely guaranteed over five to eight years from customers.
  • The long-term growth opportunity is significant as most of the US market still uses legacy systems, and other geographies are largely untapped.

Bears say

  • Product differentiation is unlikely to be durable, with low barriers to entry and larger competitors already utilizing server-side rendering and cloud-native architecture.
  • Wide adoption outside of academic hospitals is unproved, and superior speed and visualizations are likely superfluous features for the average hospital.
  • Future contract wins are likely to be smaller as Pro Medicus already dominates the larger US academic hospital market.

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

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