Treasure Chest: Has Nanosonics Been Too Successful?

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While some views on Nanosonics remain positive, recent research highlights the company may become a victim of prior success

-Nanosonics is highly leveraged to new hardware installations
-Is the capex-sensitive healthcare sector conducive to hardware upgrades?
-Goldman Sachs finds it difficult to justify the current valuation

By Mark Woodruff

Recent times have been frustrating for the shareholders of infection control technology company Nanosonics ((NAN)), as the share price is currently marginally lower than two years ago and approaching the lows reached at the height of pandemic concerns.

Since early 2020 there have been expectations for new product launches and a recovery in both capital and consumables sales to justify high historical growth rates.

In looking at a price graph, investors with a charting bent may be sensing a value opportunity, as current levels appear to provide support at around $5. But then, chartists sometimes eschew research, and the latest offering from Goldman Sachs suggests caution may be warranted.

The biggest stumbling block is the company’s impressive past, according to Goldman Sachs, with compound annual growth rates (CAGR) for sales of over 35% during FY15-20. This has resulted in a premium share price valuation relative to the sector.

The broker cites a range of factors that makes it hard to rationalise such a valuation. This includes US penetration rates approaching 70%, which make the remaining opportunity smaller and harder. Competition also potentially threatens further capital sales and the sustainability of consumables revenue.

In addition, momentum from regulatory tailwinds is fading and geographical expansion opportunities are less attractive than in the US. Finally, there’s the development pipeline, which has disappointed against expectations.

On this latter point, the biggest risk to Goldman Sachs’ Sell rating is a material, successful product launch.

New hardware installations and flow-on effects

The broker highlights the company is highly leveraged to both new hardware installations and the trend in procedure volumes. It’s thought the most attractive component of the business model is the recurrent revenue stream from the disposable cartridges necessarily/exclusively used in its trophon disinfection systems.

However, underlying demand conditions and capital expenditure levels across the US hospital channel became far more challenging through the early phases of the pandemic. The broker now expects around 4,800 installations in FY20-21 versus 6,000 previously. This deficit in turn drives a material impairment to the broker’s mid-term consumables and services sales growth profile.

While Nanosonics may be able to drive new unit sales through upgrades of existing systems (partly incentivised by the removal of service contracts on legacy systems), this does not add to the net installed base, and hence the recurrent consumables streams.

Prior to the pandemic, part of the company’s narrative was that hardware would be upgraded as the existing installed base matured beyond its useful life. However, Goldman Sachs finds age alone is rarely sufficient to drive material upgrade cycles in the more capex-sensitive healthcare sectors. Additionally, given developments associated with covid-19, it’s believed this driver will be less of a focus through the mid-term.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, yesterday downgraded its rating for Nanosonics to Sell from Neutral and lowered its 12-month target price to $4.93 from $5.50.

Bell Potter, also not one of the seven, is aligned with Goldman Sach's view and has a Sell rating with a $4.50 price target. The broker notes covid restrictions are impacting recruitment for clinical trials in the US, which suggests delays for a new product. Additionally, the outlook for revenues in Europe are impacted by ongoing government failures to contain the pandemic.

The company is covered by four of the seven stockbrokers monitored daily by FNArena. They hold quite different views as to investment prospects.

Citi sets a Sell rating and $4.30 target price and is concerned the current share price implies an accelerated launch in a significantly-sized market. Meanwhile, Ord Minnett maintains a Hold rating and $5.40 target.

By contrast, UBS is in the positive camp, expecting revenue and operating income to benefit from an expansion of the installed base, and sets a target price of $7.00 with a Buy rating.

After the recent launch of a new digital platform, AuditPro, Morgans was enthusiastic about its potential, though no changes were made to the broker’s existing forecasts. The Add rating was unchanged, with a target price of $6.57.

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