Health insurance premiums have been rising faster than the overall inflation rate for years. In response, millions of Americans have signed up for health savings accounts (HSAs) in an effort to keep their spending in check.
In this episode of The Motley Fool's Industry Focus: Healthcare, host Kristine Harjes is joined by Motley Fool contributor Brian Feroldi to discuss the trends that have driven HealthEquity's (NASDAQ: HQY) stock higher and why they think that this highflier could still be worth buying today.
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A full transcript follows the video.
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This video was recorded on Aug. 22, 2018.
Kristine Harjes: The next hidden gem that we want to spotlight today is called HealthEquity. Their ticker is HQY. They are a $5.4 billion market cap health tech company that manages health savings accounts. That begs the question, Brian, what is an HSA?
Brian Feroldi: An HSA is a way for people and employees to save money on their health spendings. Some people might be familiar with flexible spending accounts. An HSA is kind of that, but even better. The way an HSA works is that employees can put pre-tax dollars into them. The money then grows in the account tax-free. Then, as long as it's used to pay for qualified healthcare expenses, there's no tax on taking it out. It's kind of like this magical account that offers people a triple tax advantage.
Having said that, HSAs are only available to people that have a high-deductible healthcare plan. I believe that's something like more than a $1,300 per year deductible before their health benefits kick in. It's not available to everybody. But because of the general rise in insurance premiums, one of the benefits of high-deductible healthcare plans is that their premiums are much lower than they would be for a regular plan that just had a standard copay. So, because of the cost savings on the premiums, the popularity of HSAs has exploited in recent years, as more people have chosen high-deductible health plans.
Harjes: The Motley Fool just added an HSA high-deductible plan to our health plan here for employees, and I went for it. This is my first year of having an HSA. I think it's an awesome tax-saving vehicle.
Going back to the business model for HealthEquity, they basically partner between health plans and employers to offer these HSA plans to employees and members. They have four different sources of recurring revenue. That's the subscription fees from the health plans and employers, there's AUM fees -- assets under management -- there's payment fees, and there's investment fees. It seems like this is all adding up to really quick growth in revenue. What is differentiating this business model? Why couldn't some other company come in, do the same thing, take out a little bit of margin, and beat them?
Feroldi: That's a great question. They like to say that their advantage is in the services that they provide and the view they take on it. This company isn't based in Silicon Valley, but it's got that ethos up and down it. They really do what they can to put their members first. If you're a member and you go to their website, they will actually help you find local healthcare providers that charge lower prices for services. They have great customer service. When combined with acquisitions, that fact has actually allowed them to consistently take market share in the HSA market.
Rewind the clock to 2010, they had about a 4% market share in all HSAs. Fast forward to last year, that number was up to 15%. And all along the way, the number of HSA accounts in general was growing as they increased in popularity. HealthEquity's revenue growth over that time period has just been phenomenal.
Harjes: Yeah, this is a company that has crushed the market since its 2014 IPO -- much like LeMaitre did, as well. They are also a team where the culture matters, the founder is still involved, there's 19% insider ownership. It checks a lot of those boxes that you mentioned at the top of the show.
Feroldi: Just take last year as an example. Last year, their revenue grew about 29%. This business has already achieved enough scale to start producing free cash flow and net income. Because they have recurring revenue, and they've already built this platform, as they add more members to that, it doesn't cost them increasingly more money to service them. As a result, their net income has actually grown much faster than their revenue. For example, last year, they had 29% revenue growth. That translated into net income growth of 80%.
This is another business that, as you say, because of the recurring revenue, and because of the trend that it's riding, I could easily see revenue growing double digits and net income growing even faster than that for many years to come.
Harjes: I love seeing those economics in a business. Perhaps not surprisingly, this company is also "expensive" with traditional valuation metrics. What do you think about its valuation, which stands around $5 billion?
Feroldi: There's no doubt that this stock is pricey. It's trading for 22X sales, 65X next year's earnings. Investors are absolutely paying a premium if they're buying today. If you buy this stock, you truly have to believe that it can continue to grow its revenue and its net income for many years to come. I happen to believe that they can. I am personally a shareholder of this business, and I have no plans on selling.
Brian Feroldi owns shares of HealthEquity. Kristine Harjes has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.