Nanosonics Outlook Remains Clouded

Small Caps | Jan 24 2023

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

Following a change to a direct distribution model, Nanosonics has delivered a better than expected first half, but brokers remain cautious. 

-Nanosonics’ change to a direct distribution model has exceeded market expectations
-The extent of company management's H1 guidance upgrade proved larger than analysts had anticipated
-Underlying, however, there are indications momentum is slowing in the maturing US market

By Danielle Austin

A switch to a direct distribution model had sparked some concern around how Nanosonics ((NAN)) would perform in the current fiscal year, but it appears the first full half where its trophon devices were sold by direct distribution has exceeded expectations.

Nanosonics pre-reported 35% sales growth in the first half, while gross margins lifted to 79% from 77%, with the company appearing to have benefitted in the period from higher pricing as a result of the change in distribution. 

The company also issued an update to full year guidance, now anticipating revenue growth of 36-41%, from a previous 20-25%. Implied earnings of $18m for the fiscal year represent a significant beat to consensus expectations of $8m. 

The positives in Nanosonics' early 2023 market update have not eradicated analysts' concerns about the year(s) ahead. Concerns remain about a slowing of growth in base unit installations in a maturing US market, although installations did largely exceed expectations in the first half.

With Nanosonics’ sales model relying on the purchase of consumables, consistent growth in base unit installations is crucial to maintaining consumables revenue. 

Global installed base units grew by 1,270, suggesting a slowing of growth in comparison with the 1,410 units installed in the first half of the previous fiscal year. With the US market maturing, the EMEA and Australia Pacific are yet to contribute meaningfully to growth.

A mixed investment case for Nanosonics

Nanosonics is aiming to expand beyond its single product offering, targeting a launch in the flexible endoscope cleaning space in 2023. However, Ord Minnett (Lighten, target price $5.50), which downgraded its rating following the company’s pre-release, notes product development for the launch is yet to be finalised. 

With product development remaining dependent on an external clinical assessment to support the company's regulatory submission, Ord Minnett bases much of its valuation on the existing trophon product. More positively, the broker anticipates Nanosonics will be able to leverage its existing trophon distribution infrastructure to the benefit of its new product launch. 

The stronger than anticipated first half pre-release, alongside better pricing and recovery in hospital access, saw Ord Minnett lift its revenue forecast for FY23 by 7%, with little impact on following years. 

Cautionary brokers not counting chickens before they hatch 

Ord Minnett's caution is replicated across other brokers covering the company. With Nanosonics yet to release more details in February (this was only a pre-release update) many are awaiting the full release, while also bemoaning the fact the launch of product number two, Coris, is taking a long time, having repeatedly been delayed in years past.

For now, the half-yearly "beat" was supported by improved pricing from the distribution model change, analysts largely expect foreign exchange movements also proved a significant tailwind for the company. 

Wilsons, this morning, downgraded its rating for the company, to Market Weight from Overweight, believing the company has now delivered the anticipated better-than-feared separation from GE Healthcare, its prior distribution partner in the US, but now that the major catalyst has been delivered, it's time to focus on valuation with the Coris development yet to unfold. Wilsons' price target is $5 – leaving but a small gap left to close for the share price (around $4.85).

Morgans (Hold, target price $5.19) expects the result will dull some market caution, but does highlight the pre-release did not quantify whether gains were attributable to price increases or foreign exchange movement. Despite this, Morgans largely found the update to be positive, demonstrating ability to execute on the new direct sales model.

Morgans did lift its forecast, but only to the lower end of company guidance until it can gain further clarity on the breakdown of the first half result. 

Citi (Sell, target price $4.60) has lifted its earnings per share forecasts 158%, 70% and 38% through to FY25. Canaccord Genuity stuck with Hold, alongside a target price of $5.00.

Goldman Sachs (Sell, target price $4.30) highlighted Nanosonics’ update showed a meaningful slowdown in growth in the final two months of the half, but the market update did not provide any detail to explain this trend. The slowdown leaves Nanosonics tracking -15% behind the broker's estimated installed base growth. 

Bell Potter (Sell, target price $3.85) took a more optimistic tone, seeing more evidence that Nanosonics has successfully established its new distribution model. Of more concern to this broker was risk relating to the regulatory approval and commercialisation of the Coris device.

Bell Potter feels the market is already attributing significant value to Coris, which it expects will face challenges from established market participants on its path to commercialisation. 

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