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Distribution Anxiety For Nanosonics

Australia | Feb 10 2022

This story features NANOSONICS LIMITED. For more info SHARE ANALYSIS: NAN

Disappointment over first half sales and an abrupt change to a US distribution agreement sent shares of Nanosonics lower, though some brokers see value emerging.

-Nanasonics revises US distribution agreement
-First half sales miss versus the consensus estimate
-A slowdown for new installations and product delays
-Canaccord Genuity sees a buying opportunity 


By Mark Woodruff

Nanosonics ((NAN)) has surprised the market by abruptly announcing a revised reseller agreement with GE Healthcare, its primary distribution partner in the US.

At the same time, the infection prevention company released below-consensus sales figures for the first half of the financial year.

Under the new agreement, GE Healthcare will no longer hold inventory of the automated high-level disinfection device Trophon, though will continue to sell the devices to customers. 

Nanosonics will now manage all Trophon inventory, shipping, installation and training and will earn a higher margin on consumables, given existing and new customers acquired by GE will now purchase directly from Nanosonics.

As GE Healthcare will need to transition out its inventory of consumables and capital, Nanosonics has guided to a one-off FY22 revenue impact in the range of -$13-16m. Moreover, an expansion of the North American team will result in an annual 3% increase in operating expense.

First half sales were -4% below the consensus estimate though grew 40.4% year on year.

Over the course of the last year, the share price has fallen from a high of $7.52 to be currently trading at around $4.50. Morgans believes recent falls are indicative of a market confused and/or concerned with the GE transition period and a new reliance upon the company’s direct sales team.

However, one broker spies a strong buying opportunity for investors, with the company’s multiples falling below long-term average levels.

The reseller agreement

GE Healthcare accounted for around 60% of revenue for Nanosonics in FY21, of which around 80% was from consumables.

Citi feels consumables should not be impacted and sees the transition to a direct model in North America as a natural evolution. While there are negative revenue and cost implications as a result of the transition, the broker expects higher revenue and profit by going direct.

Wilsons is positive on the change to the reseller agreement, as it should create new business from ultrasound original equipment manufacturers (OEMs) including Toshiba, Hitachi and Philips. It’s felt OEMs currently access Trophon in a sporadic, client-driven way.

While changes can potentially improve the gross margin profile on recurrent consumables sales, Goldman Sachs cautions the logistical complexity of the business is materially increased. Moreover, there’s a risk some customers are slow to transition or never do so.

The broker sees clear risk the company cannot sustain historical rates of momentum in new/upgraded hardware sales and lowers its target price by -14% to $3.80, retaining its Sell rating. 

The change of agreement has prompts Ord Minnett to take a more conservative view of future revenue and earnings growth and the broker downgrades its rating to Lighten from Hold. 

Ords lowers its target price to $4.05 from $6.40 and notes the valuation risks inherent in a rising interest rate environment.

Value on offer?

Canaccord Genuity upgrades forecasts for revenue and margins in both FY23 and FY24 and raises its target price to $7.67 from $7.42, as the company’s multiples are now below long-term average levels. A Buy rating is retained.

The analyst points to the confidence inherent in Nanosonics largely taking over the sales function, owning the end-customer and better controlling its growth drivers.

Some in the market believe Nanosonics is already responsible for most demand generation and suggest GE Healthcare largely closed sales at a discounted price. If this was the case, Canaccord feels the company will comfortably achieve its sales targets.

New product delay

Morgans' FY23 and FY24 revenue forecasts of $8.3m and $10.1m, respectively, contain a contribution from the yet-to-be launched flexible endoscope cleaning product named Coris.

Morningstar believes the market has gotten ahead of itself in relation to this product. An external clinical assessment is still required before product development is finalised. Upon release, Nanosonics will utilise its existing distribution infrastructure.

Installation run-rate concerns

Since 2017, new installations have generally fallen every year in North America, reminds Morningstar, as the Trophon device is already in around 85% of US hospitals and significant replacement sales are unproven.

The installation run-rate has declined from 2,000 in the second half of FY16 to 1,360 in the first half of 2020 pre-pandemic and trading conditions have worsened since.

Also, despite a presence since 2015 in Europe, the company has been faced with stiff competition and has struggled to build awareness, according to Morningstar.

Overall, FNArena’s database has three broker ratings with one Buy and two Sell or equivalent and a consensus target price of $5.00, which suggests 11.3% upside to the last share price.

For those brokers that are not in the FNArena database, Morningstar retains its $3.50 fair value estimate, while Wilsons maintains its $7.18 target price and Market-weight rating. The ratings and targets for Goldman Sachs and Canaccord Genuity are mentioned above.

First half FY22 results are due on Thursday, 24 February.

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