Monday 20 July 2015

Growth Portfolio: Healthcare (NAN, CSL, SOM, JHC)

Nanosonics

Valuation

Market Price: $1.78
Current Value ~ $2
Future Value FY1: ~ $2.20
Future Value FY2: ~ $2.40

Business

Nanosonics Ltd was founded in 2001 and has headquarters in Sydney, Australia. Offices extend to USA and Europe. They operate in the healthcare sector focusing on development of innovative technology for infection control purposes. This technology can be applied for a range of industries.

Analysis

A new study conducted by Nanosonics concluded that the medical field should strongly consider the results of their research, hence inferring increased demand for Nanosonic products and revenues. The soaring share price increased in May this year following the announcement that of a new study which showed their Trophon ® EPR, their ultrasound high level disinfection system, was unique in its ability to kill natural infectious high risk HPV given normal conditions. High risk HPV accounts for 5% of all cancers. This caused a share price rise of 12% to finish at $1.72. Considering their previous high was at $2.02, there is high room for growth, especially given that Nanosonics operates to serve a niche market who are likely to have inelastic demand for such healthcare products, thus has high probability to prompt a re-pricing. This is likely as it has proven to be more effective than standard routine disinfections and wipes in use in hospitals and clinics nowadays. With a current market share of 30% in Australia and with rising sales, the company can easily achieve offshore profits as well. Industry numbers imply the market for ultrasound systems that Nanosonics offers is worth $US4.5 billion and the company already has locked in an exclusive distribution agreement with GE in the USA. In FY14, sales reached $24 million, and sales are expected to increase to $39.4million in FY16, which facilitates profits. Drops in profits can be attributed to development of other products (increase in CAPEX) though this should only hinder profitability in the short term.

CSL

Valuation

Market Price: $93
Current Value: $93
Future Value FY1: $97
Future Value FY2: $109

Business

CSL is an Australian pharmaceuticals company. In Australia, bioCSL manufactures and in-licenses, markets and distributes vaccines with particular focus on vaccines for the prevention and treatment of serious disease. CSL Behring Australia supports all aspects of the process from the collection and testing of donated plasma through to the production of a range of plasma-derived products. CSL Behring is the chosen national fractionator of Australia, New Zealand, Hong Kong, Malaysia, Singapore and Taiwan. In October 2014, CSL announced it would acquire Novartis’ influenza vaccine business to integrate with BioCSL’s current influenza business.

Analysis

In the first half of FY15, revenues increased 8% to US$2.74 billion. The segment which generated the highest revenues was CSL Behring (87%), whose revenues improved by 8% due to strong sales demand from Hizentra and Privigen in China’s hospitals, but competitive pressures reduced prices across their products. This competition came from European companies looking to increase their $US denominated sales. However, due to economies of scale in global networks (more than 65 laboratories in USA and Germany) and strict licensing requirements for collection and testing of plasma, there are high barriers for new entrants. CSL, Baxter and Grifols dominate the market and together add up to 85% of market share supply. This sustains industry profits. bioCSL accounted for 10% of revenues, which increased by 15% due to flu season in the northern hemisphere. CSL IP revenue decreased from the previous FY by 8% due to cuts in royalty payments from the HPV vaccine, though it only accounted for 3% of total group earnings.  Overall, this meant net profits rose by 7% to US$692 billion, and profit margins expanded to 31%. However it should be noted that the previous period included a class action settlement worth US$39 million. This helped boost their interim dividend by 9% to $US0.58 Approximately 8% of revenues are allocated to R and D, ensuring sustainable future growth. Historically speaking in the past ten years, R and D has been successful in developing 17 product approvals and registrations.  Their resulting patents ensure that competitors do not replicate their innovation for years, boosting pricing power due to relatively inelastic demand.  Their acquisitions have also achieved leverage and scale. They have managed to generate high amounts of capital, which is impressive given $2300 million worth of equity reductions from FY10-14 from buying back shares. Net return on equity rose in the corresponding period from 18 to 58%. They have moderate gearing, with a 42% debt to equity ratio. Gearing is supported by steady growth in operating earnings hence the interest coverage ratio of 32. Their $950 million share buyback split over FY15 further demonstrates a strong balance sheet with high potential for earnings growth.  However, there are short term pressures in trading conditions in their market which will impact net income. Management downgraded net income growth expectations by 2%. In the long term their therapies, offshore expansion into Asian emerging markets and the aging population in advanced economies (correlated with increased healthcare expenditure) will drive profits.

Key Risks

The main risk is if there is a material change in competitor supply which would affect the market’s equilibrium supply demand curve and hence product prices given their monopolistic nature. Whilst their plasma products are not discretionary, cyclical conditions are worsening globally which prompts governments to reduce their budget expenditure on the healthcare sector, which limits the company’s pricing power. Regulatory changes regarding product quality and/or safety likewise impacts reputation and hence sales.

JHC

Valuation

Market Price: $2.60
Current Value: $2.65
Future Value FY1: $2.68
Future Value FY2: $2.69

Business

Japara Healthcare Limited (JHC) is one of the residential aged care operators of healthcare services in Australia, with 3,391 places across 39 facilities located in Victoria, New South Wales, South Australia and Tasmania. Currently, JHC operates in Residential Aged Care sector, a sub-sector of the aged care industry. The Company operates through an aged care organization, ACSAG and Japara Retirement living.

Analysis

JHC is one of Australia’s leading aged care operators, meaning increased demand for aged care services compliments their growth strategy. Naturally this would also introduce threat of new entrants and competitive pressures, however the government’s controlled expansion of aged care residential facilities, licensing requirements and high compliance costs create barriers to entry, and supports already established and reputable monopolies. JHC aims to use brownfield and metropolitan greenfield projects to increase capacity. This means they are also in prime position to make acquisitions to enhance their portfolio from 3131 places to approximately 5000, as the aged care sector is very fragmented- the leaders account for only 10% of market share. Their Whelan acquisition increased places by 27%, and total occupancy was 94.4%, a percentage increase from FY14. Further growth strategies could increase their debt ratios however in Jan 2015 JHC had repaid all debt with $95 million available in loan facilities to fund growth. Moreover, JHC has proven to be effective in cost efficiency gains as well as revenue increases- average EBITDA per bed count increased by $21,761, a 15% boost from FY14, which increased EBITDA by 28% to $26 million.

Key Risks

Earnings are exposed to regulatory changes, as the government subsidises approximately 70% of operating revenues. Aged Care Funding Instrument is the main source of funding and is based on residents’ income and necessary care level. Fee regulation therefore decreases JHC’s pricing power, and JHC must continue to ensure costs are managed accordingly to sustain margins. Nevertheless, management estimates an increase of 80,000 aged care places by 2022, increasing sector investment by $25 billion.


SomnoMed


Valuation

Market Price: $2.90
Current Value ~ $3.30
Future Value FY1: ~ $3.30
Future Value FY2: ~ $3.35

Business

SomnoMed is a sleep organisation based in Sydney which designs and manufactures a premium range of oral appliances for sleep breathing disorders such as sleep apnoea. They are a market leader in their Continous Open Airway Therapy products and have recently expanded business to Europe and US whilst expanding product range. 45% of revenue is sourced from the US and 45% is from Europe.  

Analysis


The share price drop which followed a May announcement was due to an announcement that SomnoMed’s sales were lower than expectations, meaning their final volumes were between 50000 to 55000 units. However, this would still mean their YoY growth is 17%, and revenues are still expected to increase more than 25% in FY15. Over the next year the company will begin to include its digital record transmission product into its portfolio, which offers a positive share price catalyst amongst rising international sales and demand. Its recent release of Herbst Advance commences sales in September, and will account for more than half of existing Herbst sales. Product portfolio growth is both for upscale market as well as the lower end market. For instance, Fusion is an upmarket product which will replace Flex over the next 2 years. Innovation drives constant earnings growth. Air and Air+ have a December launchdate and targets lower end markets which is an effective strategy given that this accounts for almost a third of their total market. It will still maintain similar margins. Such catalysts increase long term growth rate to 30%.

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