Ongoing Optimization To Maximize The Value
publication date: Mar 26, 2018
author/source: Valuentum Analysts
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Structure of the Diagnostic Substances Industry
Firms in the diagnostic substances industry make clinical diagnostic test kits for gastrointestinal, viral, respiratory and parasitic infections in humans and point-of-care veterinary diagnostic products for the companion animal veterinary, livestock and poultry markets. The global market for tests continues to expand as new disease states are identified and new therapies become available. There is also a trend toward more technologically advanced testing, which can be performed by less highly trained personnel and completed in minutes or hours (as opposed to days). We like the group structure, though rivals are highly competitive.
Abaxis' point-of-care veterinary products now extend to over 85% of target veterinary practices.
Abaxis develops and manufactures point-of-care blood analyzers which provide clinicians with rapid blood-constituent measurements for both humans and animals. The analyzers are designed to provide on-the-spot results. The company operates in two segments, Medical Market and Veterinary Market. It was founded in 1989 and is headquartered in Union City, California.
Abaxis has recently landed a major new Tier 1 distribution partner. Its point-of-care veterinary products now extend to over 85% of target veterinary practices--doubling its reach prior to the deal.
The firm believes that a key element of the health care system will be the availability of blood analysis systems in the patient-care setting that are easily and reliably operated by caregivers and that provide accurate, real time results to enable rapid clinical decisions. Abaxis is well-positioned to capitalize on this trend.
Abaxis has a number of on-going research and development initiatives underway that are expected to make significant contributions to future operational results, which include the development of electronic connectivity technology as well as a number of high sensitivity immunoassay projects that will expand its offerings to the veterinary and medical markets.
Competition in the human and veterinary diagnostic markets is intense, however. Its principal rivals in the point-of-care human diagnostic market are Alere, Abbott, and Johnson & Johnson.
Our published fair value estimate range for Abaxis is $34-$52 per share, with a Valuentum Buying Index rating of 6 and an Economic Castle rating of Very Attractive.
Impressive momentum in IDEXX's Companion Animal Group has led to multiple 2017 EPS guidance increases. Our mid-cycle assumptions do not allow for much room for error.
IDEXX is a leader in pet healthcare innovation, serving practicing veterinarians around the world with an integrated portfolio of diagnostic and information technology-based products and services. The company continues to experience momentum with instrument placements, and excitement surrounding its next generation catalyst analyzer, Catalyst One, is high.
Few other companies are generating the pace of organic growth like IDEXX. For example, the firm posted 10% organic expansion in the second quarter of 2017 thanks to strong growth in its Companion Animal Group (IDEXX VetLab consumables), which makes up more than 80% of revenue.
IDEXX believes it has potential for sustained annual earnings per share growth of 15%-20%+. It expects to achieve this through revenue growth of 9%-13%, operating margin expansion greater than 50 basis points, and 3%-4% incremental EPS growth due from capital allocation leverage. The Catalyst One is expected to support continued growth in recurring revenues.
IDEXX is expecting revenue to be between $1.95- $1.96 billion in 2017 and adjusted earnings per share to be in a range of $3.22-$3.26, or ~32%-34% growth over 2016. Though our estimates for 2017 are in line with company guidance, our mid-cycle assumptions do not allow for much room for error. Shares look pricey.
The firm competes with many companies ranging from large human pharmaceutical and medical diagnostics companies to small businesses focused on animal health. We believe competition is intensifying.
Our published fair value estimate range for IDEXX is $80-$133 per share, with a Valuentum Buying Index rating of 3 and an Economic Castle rating of Very Attractive.
Weakness in Meridian's core diagnostics business in the US has impacted recent results, and slow organic growth could push it into action on the M&A front.
Meridian is a life science company with principal businesses in making clinical diagnostic test kits, bulk antigens, antibodies, PCR/qPCR reagents, nucleotides, proteins and other biologicals. Diagnostic products represent ~75% of revenue. The company was founded in 1976 and is headquartered in Cincinnati, Ohio.
Shares of Meridian were punished in early 2017 after a downward revision to top- and bottom-line guidance and a reduction in its quarterly dividend. The company expects fiscal 2018 revenue to be in a range of $207-$212 million and earnings per share to be in a range of $0.59-$0.62.
Weakness in Meridian's core diagnostics business in the US was a key factor in its downward guidance revision and dividend cut. Customer buying patterns and competitive market conditions contributed to the disappointing results, and the firm's patents on its H. pylori products expired in the US in May 2016 and expire worldwide in 2017. More recent trends in its diagnostics business have been encouraging.
The global market for infectious disease tests continues to expand as new disease states are identified, new therapies become available, and worldwide standards of living and access to health care improve. Meridian's position has become less attractive with its recent patent expirations
Meridian has been active on the acquisition front of late in order to add growth and capabilities. The firm has the necessary structure, balance sheet, and market access to support and grow acquired companies. Slow organic growth could push the firm into action.
Our published fair value estimate range for Meridian is $10-$16 per share, with a Valuentum Buying Index rating of 7 and an Economic Castle rating of Attractive.
Meridian cut its dividend in January 2017 as a result of weakness in its US diagnostics business and key patent losses. We don't expect another cut, however.
Meridian’s operating income and net income hit near-term peaks in fiscal 2013, and the company is still working to surpass those highs. Revenue growth has been robust in recent years, and the company's balance sheet had been debt free until the Magellan acquisition recently. Meridian’s diagnostic products are well-positioned in the areas of gastrointestinal, upper respiratory, serology, parasitology and fungal disease analysis. Fiscal 2015 marked its 25th consecutive year of paying a dividend, but the company cut its quarterly dividend after reassessing its fiscal 2017 outlook in January of the year. Capital spending is but a fraction of free cash flow generation, but free cash flow coverage of annual cash dividend obligations have become stretched.
Though we don’t have any qualms with Meridian investing for the future, spending on R&D and international expansion efforts (including China) are a normal course of business at the company. As with all companies operating in the healthcare vertical, the industry is in a state of flux as it seeks better value at the most efficient cost. Key rivals in molecular diagnostics include Cepheid, Becton Dickinson, and Alere. Acquisitions have been a key source of growth in Meridian’s business in the past, and its deal for Magellan put an end to its debt-free balance sheet. Implications of expiration of its H. pylori patents should be watched closely, and the loss of such patents came back to haunt Meridian.
Our published Dividend Cushion ratio for Meridian is 1.9 with a Dividend Track Record of Risky.
We've raised our fair value estimate for Neogen after increasing top-line expectations and lowering our cost of capital assumption. Its position in helping improve the safety of food supplies is undeniably strong.
Neogen develops and markets dehydrated culture media, and rapid diagnostic test kits to detect foodborne bacteria, spoilage organisms, mycotoxins, food allergens, genetic modifications, and sanitation concerns. Food safety revenue accounts for about half its business, with the balance coming from animal health.
The company's recent performance has been impressive. In its fiscal 2017, Neogen produced 13% revenue growth and has delivered revenue growth in each quarter for the past 12 consecutive years. It often sets double-digit organic growth as a quarterly target.
Neogen's strategy may be unique, but competition for each of its individual products is intense. Though the development of new technologies will pose challenges, the cases related to food poisoning continue to increase, driving ongoing opportunities for business growth. The global agricultural rodenticide market offers promise.
International expansion continues to be a large part of Neogen's growth plan. As of fiscal 2017, international sales made up just over 35% of revenue. The firm believes two-thirds of its opportunities lie outside of the US, and it is quick to highlight a new sales presence in China and India. It also has direct-to-market operations in Europe and Latin America.
Synergistic acquisitions are a key component of Neogen's growth strategy. Since 2000, the company has made more than 35 acquisitions, which have driven about half of its historic growth rate. Investors should expect more on the horizon.
Our published fair value estimate range for Neogen is $41-$68 per share, with a Valuentum Buying Index rating of 4 and an Economic Castle rating of Attractive.
Oxford Immunotec (OXFD)
Though Oxford Immunotec continues to lose money, it is confident is has enough cash to get itself to profitable levels.
Oxford Immunotec is a diagnostics company that develops and commercializes proprietary tests for the management of immune-regulated conditions--chronic infections, transplantations, autoimmune and inflammatory, and immune oncology--in the US, Europe, Japan, and China. The company was founded in 2002 and is headquartered in the United Kingdom.
The company is a highly speculative investment idea. Not only has it not yet turned a profit, but its market cap is borderline micro territory. We would expect shares to be incredibly volatile. In a tightening credit environment, Oxford may encounter difficult times.
Though Oxford Immunotec has yet to turn the corner with respect to profitability, it seems to be on the right path. The fourth quarter of 2016 was encouraging as revenue increased 39% in constant currency, which exceeded expectations, and gross margin expanded nearly 2.5 percentage points (though this may continue to be volatile). Management has been pleased by progress in its pipeline as well.
Oxford Immunotec develops its products using its TSPOT platform, which is exquisitely sensitive and measures the functional responses of multiple cell types at a single-cell level. Its T-SPOT.TB is an early detector of TB and is experiencing rapid commercial growth. The commercial launch of T-SPOT.CMV took place in the second half of 2016.
The firm's T-SPOT technology has gained global regulatory approval. It believes the TB market is underserved and represents a >$1 billion market opportunity. Though it continues to lose money, the company is confident is has enough cash to get itself to profitable levels.
Our published fair value estimate range for Oxford Immunotec is $3-$19 per share, with a Valuentum Buying Index rating of 3 and an Economic Castle rating of Unattractive.
Quidel Corp (QDEL)
We've raised our fair value estimate for Quidel after increasing expectations related to its acquisition of certain Alere assets, which will materially diversify its revenue base. A lower cost of capital has been assumed as well.
Quidel Corp is a leader in the development, manufacturing and marketing of rapid diagnostic testing solutions. These diagnostic testing solutions primarily include applications in infectious diseases, women’s health and gastrointestinal diseases. The company was founded in 1979 and is headquartered in San Diego, California.
Though earnings haven't been great, the company continues to make progress with product development. It continues to receive clearance from the FDA on a wide variety of molecular assays. Such traction should help drive future results.
Quidel has agreed to acquire Alere's Triage cardiovascular and toxology assets and the BNP assay run on Beckman Coulter analyzers for a consideration of $400 million plus $40 million contingent consideration and $240 in deferred consideration. The deal is expected to be accretive to EPS to GAAP EPS. Delevering will be a priority upon closing as adjusted debt-to-EBITDA is expected to be ~4x.
Quidel's longer-term financial goals include achieving low-to-mid teens annual revenue growth through new product introductions, investing in the development and commercialization of new products to drive gross margins past 65%, and leveraging operational efficiency to drive EBITDA margins in excess of 30%.
Competition in the development and marketing of diagnostic testing products is intense, and innovation, product development, regulatory clearance to market and commercial introduction of new technologies can occur rapidly
Our published fair value estimate range for Quidel Corp is $22-$32 per share, with a Valuentum Buying Index rating of 1 and an Economic Castle rating of Very Attractive.
Trinity Biotech (TRIB)
Trinity Biotech is a speculative idea, and its debt load has grown in recent years.
Trinity Biotech acquires, develops, manufactures, and markets medical diagnostic products for the clinical laboratory and point-of-care segments of the diagnostic market. Its customers include public health facilities, hospitals, clinical and reference laboratories, and other outreach facilities. The company was founded in 1992 and is headquartered in Bray, Ireland.
Trinity has grown through a number of small acquisitions in recent years. The firm's long-term debt load has ballooned to more than $92 million as of the end of 2016 from nothing at the end of 2014. We still expect it to explore more M&A options.
2015 and 2016 were difficult years for Trinity after multiple years of double-digit top-line growth. Gross margins have been under pressure due to lower Lyme disease revenues and currency headwinds. Shares and expectations were punished in fall 2016 as a result of the firm withdrawing a marketing application from the FDA for its Meritas Point-of-Care Analyzer and Meritas Troponin-I Test.
Trinity operates in five segments: cardiac, diabetes, infectious diseases/autoimmune, HIV, and life science supply. Its infectious disease lab business is generating solid cash flows and profitable growth, specifically in China and Brazil. The firm believes it has a significant growth opportunity in its syphilis rapid test.
Investors should be aware that Trinity is not immune to foreign exchange fluctuations and irregular order patterns related to its products. Pre-launch sales and marketing costs can also eat into margins.
Our published fair value estimate range for Trinity Biotech is $4-$11 per share, with a Valuentum Buying Index rating of 3 and an Economic Castle rating of unattractive.