A miss from Nanosonics... is it time to buy?
Throughout the time of COVID-19, healthcare stocks have been catching the eyes of investors. You would have thought that a company that specialises in infection prevention and disinfection practices would be over-performing at a time where headlines are dominated by obligatory mask wearing, hand sanitiser and a worldwide pandemic. But the result delivered today from Nanosonics was a definite miss.
Nanosonics, the innovator of ultrasound probe disinfection practices, delivered a result that missed market consensus expectations on their EBIT and profit line. Yet this company is still considered a monopoly player, with a long runway for growth, new products on the horizon, and a large addressable market. So, despite poor results, is it a buy?
Jun Bei Liu of Tribeca thinks that whilst the company's results were disappointing and missed expectations, given the current environment and the focus on COVID-19, the results are understandable. Liu also believes that Nanosonics' fundamentals and growth prospects make it a company worth owning.
How long have you held the stock?
We have held an overweight position since early 2019, and smaller positions before that.
How big a position is the stock for you currently?
Currently Nanosonics is a smaller position in our portfolio as we trimmed back the position post significant price appreciation relative to the market around 4 months ago.
What are some of the key reasons you’re attracted to the company?
While we had been favourably disposed to Nanosonics prior to the pandemic we had become concerned it faced a challenging period given the disruption to the hospital system caused by COVID. As revealed by today’s result our concerns over a drop in capital spending (i.e. new device sales) were borne out as the medical community’s focus turned to treating COVID patients and consumable sales fell as elective surgery, including ultra sound procedures, were put on hold.
Looking beyond the immediate COVID challenges we are wary hospital capital budgets will be constrained for the next year or so after the significant financial impact of the pandemic on both hospitals and Governments budgets. While Nanosonics can circumvent this capital shortage by offering rental arrangements it is not an ideal environment into which to launch a new product. This is particularly important as by our estimates a significant portion of the group’s current share price reflects the regularly promised but as yet unreleased new devices. And at today’s result the company announced the launch of this new product has been delayed to FY22 (previously expected this financial year) and again has not revealed any details about what it is working on.
Longer term we believe Nanosonics can again be an exciting medtech growth story following in the footsteps of Cochlear and Resmed. The company has an attractive business model with annuity revenues from its proprietary consumables along with services revenues. It’s leveraged to a growing and global installed base with nearly 24,000 trophon devices currently sold worldwide, the majority into the United States.
A little bit of background. Nanosonics’ trophon device was launched in the US nine years ago and has developed a strong following and brand loyalty with clinicians due to its speed, safety, ease of use and relatively lower cost compared with other High-Level Disinfection products. The advantage is the disinfection time for ultrasound probes – Nanosonics’ device cleans in 10 minutes versus the 35 minutes it takes to clean an ultrasound probe manually. Given the high cost of medical services, this represents an attractive saving to hospitals. Additionally the RFID tracking abilities of its newer trophon2 model, released in 2018, allows easier compliance with the growing audit requirements hospitals face.
The business has delivered phenomenal growth with sales almost quadrupling since FY15. The dramatic sales growth has propelled the company from losses in FY15 to strong profits. And despite this success, Nanosonics has barely broken into Europe and Asian markets. The European market introduced High Level Disinfection guidelines for ultrasound probes in the last few years and current penetration rates in large addressable markets such as Germany, France and Spain are still low. Japan has yet to introduce guidelines on ultrasound High Level Disinfection, although this is anticipated to be coming soon. We think Nanosonics stands to capture a large share of Japan’s ~10k unit addressable market once guidelines are implemented.
The company has a leading share in North America accounting for approximately half of all the High-Level Disinfection devices in hospitals and other health settings. And the uptake of its disinfecting devices is supported by long standing regulatory requirements for infection prevention which also acts as a barrier to new entrants.
What were the key points of the recent result?
Turning to today’s results, we learnt revenues slowed sharply in the June quarter, up only 1% as COVID hit the US particularly hard. This was a big change in momentum for the company after growing by more than 25% in the first three quarters of the year. The growth in its installed base of trophon units (a measure of new units sold) stalled during 4Q as hospitals diverted their attention to treating COVID cases and hospital access was limited for the sales teams. Sales of consumables and services from the installed base held up better but this also slowed as the number of ultrasounds undertaken dropped as elective medical procedures were put on hold across most of the globe. This has since begun to recover as elective surgery picks up and we are hopeful of a bulge in demand as health systems seek to address the lengthening waiting lists.
How did the results compare with your expectations? And those of the broader market?
The result missed consensus expectations at both the revenue line (6% below) and at the profit line (an 18% miss) as costs were higher than expected. This in part reflects the company’s commitment to R&D which is especially important as it seeks to bring a new product to market. The lift in costs was also due to the expansion of the sales force in Europe and Japan to support its market growth plans. While gross margins also fell short of the market expectations we were in fact impressed by the improvement given the challenging environment.
Were there any surprises?
The key surprise with the result was the disappointing delay in the planned launch of the new device and the ongoing lack of detail on what is planned. While no doubt this is in the best interests of the business it has become a point on frustration particularly given the high hopes some in the market have for this new offering.
Has your position on the stock changed post results? Why / Why not?
We still believe Nanosonics is a solid business with a large market opportunity ahead of it. The management team is impressive with many of them having come from other large and successful Medtech businesses, including Cochlear and ResMed. Nanosonics also has strong business partnerships with global distributors such as GE healthcare giving it a supportive platform for growing its installed base.
One of our laggards on the 10 most-tipped list, down ~3% since the start of the year, NAN is still one of the most popular stocks amongst both fundies and retail investors. At the end of 2019, two of our fundies nominated Nanosonics as the one stock they'd love to own at a cheaper price. Whilst Jun Bei has noted that the company has a cloudly outlook, she also revealed that she is keen to re-establish her over-weight holding in the company post results, given its resilient nature. After it bounced hard out of its March lows and is now sitting at a cheaper price than last year.
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