Nanosonics (NAN) BUY: Nanosonics investing in its next phase. Key points. Risks and catalysts

Transcription

1 Date 28 August 2017 Theme Financial Results Company Nanosonics (NAN) BUY: Nanosonics investing in its next phase We maintain our BUY rating with a revised price target of $3.10 per share. Nanosonics FY17 results were broadly in line, reporting normalised NPAT of $13.9m and strong cash generation. Management signalled the start of a new investment phase to accelerate growth in Europe, target market development in Japan and the Middle East and launch at least two new products over the next two years. The outlined investments significantly reduce our short-term earnings forecasts. Importantly, the US business remains in growth phase, providing both the stability and capital to push Nanosonics intellectual property assets harder and through to their full potential. Nanosonics remains on Wilsons Conviction List. Key points FY17 result snapshot. Nanosonics reported a solid operating result for FY17. Revenue grew 58% to $67.5m (in line). Operating expenses were $1m higher than our forecast, but we were pleased with normalised NPAT of $13.9m and $16.4m in operating cash flow. Nanosonics is starting FY18 with a global installed base of at least 14,100 Trophons: a 40% increase on pcp, driving consumables and services revenue uplift. The balance sheet is in great shape at $61m net cash fully funded to pursue international growth and R&D plans. Guidance and model changes. Our short-term NPAT forecasts are significantly lower than when we last published forecasts in February down 66% in FY18e and 45% in FY19. Note four principal drivers: a) moderated rate of US Trophon adoption, having observed a reduction in 2H17 sales v 1H17; b) management s expense guidance on R&D/SG&A in FY18 being ~$10m higher than our forecast, principally directed at ex-us market acceleration; c) updating our EMEA model to capture the increasing popularity of Managed Equipment Service (MES) contracts versus the traditional capital equipment sales model; and d) FX revisions impart their own ~3% headwind to NPAT. Valuation. Our primary NAN valuation is a DCF which values the international Trophon business at $2.60 per share. The MES-related changes had a more modest impact on DCF short-term reductions offset by increased Trophon adoption rates and higher (albeit back-ended) consumable revenue and gross margin. We add a nominal $0.50 per share for new product opportunities, based on a risked NPV approach. Nanosonics intends to launch at least two new products over the next two years. Specifics were not discussed for competitive reasons, other than to say the focus remains disinfection and that the products have higher earnings potential than Trophon. Risks and catalysts Important risks and catalysts are listed on p.7 of this report. Important Risks: a) slower-than-forecast sales growth; b) slow business Earnings forecasts Year-end June (AUD) FY16A FY17A FY18F FY19F FY20F NPAT rep ($m) NPAT norm ($m) Consensus NPAT ($m) EPS norm (cps) EPS growth (%) P/E norm (x) EV/EBITDA (x) FCF yield (%) DPS (cps) Dividend yield (%) Franking (%) Source: Company data, Wilsons estimates, S&P Capital IQ Recommendation BUY 12-mth target price (AUD) $3.10 Share 25-Aug-17 (AUD) $2.50 Forecast 12-mth capital return 23.8% Forecast 12-mth dividend yield 0.0% 12-mth total shareholder return 23.8% Market cap $744m Enterprise value $676m Shares on issue 298m Sold short 0.7% ASX 300 weight 0.0% Median turnover/day Shane Storey, PhD MBA shane.storey@wilsonsadvisory.com.au Tel mth price performance ($) $2.5m 2.00 Aug-16 Dec-16 Apr-17 Aug-17 NAN XSI Rebased 1-mth 6-mth 12-mth Abs return (%) Rel return (%) Key changes 21-Feb After Var % NPAT: FY18F % norm FY19F % ($m) FY20F 22.4 EPS: FY18F % norm FY19F % (cps) FY20F 7.5 DPS: FY18F % (cps) FY19F % FY20F 0.0 Price target: % Rating: BUY BUY Issued by Wilsons Advisory and Stockbroking Limited ABN Australian Financial Services Licence No , a participant of ASX Group and should be read in conjunction with the disclosures and disclaimer in this report. Important disclosures regarding companies that are subject of this report and an explanation of recommendations can be found at the end of this document.

2 Price target DCF methodology Valuation WACC (%) 10.0 Terminal growth assumption (%) 3.5 PV of forecast FCFs ($m) 236 PV of terminal value ($m) 469 Enterprise value ($m) 705 Net debt/(cash) ($m) -68 Equity value ($m) 773 Price target Key assumptions Year-end June (AUD) FY13A FY14A FY15A FY16A FY17A FY18F FY19F FY20F Revenue growth (%) EBIT growth (%) , NPAT growth (%) , EPS growth (%) , EBIT/sales (%) Tax rate (%) ROA (%) ROE (%) Trophon DCF ($/sh) 2.60 R&D options ($/sh) 0.50 Price target ($/sh) 3.10 Interims ($m) Half-year (AUD) Dec 16 Jun 17 Dec 17 Jun 18 1HA 2HA 1HE 2HE Sales revenue EBITDA EBIT Net profit Norm EPS EBIT/sales (%) Dividend (c) Franking (%) Financial stability Year-end June (AUD) FY17A FY18F FY19F Net debt Net debt/equity (%) <0 <0 <0 Net debt/ev (%) <0 <0 <0 Current ratio (x) Interest cover (x) <0 <0 <0 Adj cash int cover (x) <0 <0 <0 Debt/cash flow (x) Net debt (cash)/share ($) <0 <0 <0 NTA/share ($) Book value/share ($) Payout ratio (%) Adj payout ratio (%) EPS reconciliation ($m) FY17A FY18F Rep Norm Rep Norm Sales revenue EBIT Net profit Notional earn Pref/conv div Profit for EPS Diluted shrs (m) Diluted EPS (c) Returns FY17A FY18F FY19F FY20F ROE (%) ROIC (%) Incremental ROE Incremental ROIC Profit and loss ($m) Year-end June (AUD) FY13A FY14A FY15A FY16A FY17A FY18F FY19F FY20F Sales revenue EBITDA Depn & amort EBIT Net interest expense Tax Minorities/pref divs Equity accounted NPAT Net profit (pre-sig items) Abns/exts/signif Reported net profit Cash flow ($m) Year-end June (AUD) FY13A FY14A FY15A FY16A FY17A FY18F FY19F FY20F EBITDA Interest & tax Working cap/other Operating cash flow Maintenance capex Free cash flow Dividends paid Growth capex Invest/disposals Other inv flows Cash flow pre-financing Funded by equity Funded by debt Funded by cash Balance sheet summary ($m) Year-end June (AUD) FY13A FY14A FY15A FY16A FY17A FY18F FY19F FY20F Cash Current receivables Current inventories Net PPE Investments Intangibles/capitalised Other Total assets Current payables Total debt Other liabilities Total liabilities Minorities/convertibles Shareholder equity Total funds employed Page 2

3 : FY17 result review Table 1: Nanosonics 2H17 and FY17 results versus pcp and Wilsons estimates ($ in mn) FY16 1H17 2H17 FY17 %chg Forecast %chg Var (abs$) %var Group revenue % % 0.3 0% USA % % 0.0 0% Europe, other % % (0.3) -15% APAC % % % COGS % % (1.1) -6% Gross profit % % 1.3 3% SG&A, other % % 1.5 6% R&D % % 0.8 9% Operating result (0.4) nm 13.8 nm (1.0) -7% D&A % 1.3-1% (0.0) -2% EBITDA nm 15.1 nm (1.0) -7% Net Interest, other (0.5) (0.4) (0.5) (1.0) 99% (1.0) 104% 0.0-2% Pre-tax profit nm 14.8 nm (1.0) -7% Tax expense (benefit) - (11.7) (0.6) (12.3) nm (17.9) nm 5.6 NPAT nm 32.8 nm (6.6) -20% Normalised NPAT nm 14.8 nm (1.0) -7% Diluted EPS (cps) nm 5.0 nm (0.4) -8% Operating cash flow % % 1.1 7% % of net revenue FY16 1H17 2H17 FY17 FY17e Gross profit 75.2% 72.8% 76.0% 74.3% 75.0% SG&A 59.0% 33.7% 49.8% 41.2% 46.2% R&D 17.0% 11.9% 16.5% 14.1% 11.6% Group EBITDA 2.3% 28.9% 11.8% 20.9% 19.4% Normalised NPAT 0.3% 28.4% 11.4% 20.5% 22.1% FY17 Guidance nil Source: NAN, Wilsons estimates Income statement Medical device revenue of $67.5m was just ahead of our forecast of $67.2m. Jurisdictionally, the USA business was in line at $62.3m; Europe missed slightly (we had not taken MES contract accounting into consideration for the period) and APAC beat forecasts by $0.5m with some new Trophon adoption and higher consumables sales. Gross margin was broadly in line at 74.3% and EBITDA of $14.1m was $1m lower than our estimate, with additional R&D and SG&A expense. Ignoring the one-off tax credit of $17.9m, we assess normalised NPAT of $13.9m for FY17. US installed base reached 12,400 Trophons. 2H Trophon sales of 3,700 units was slightly better than our forecast of 3,600. Consumables and service revenue correspondingly a little below estimates. Rest of world installed base 1,700. Nanosonics plans to invest significant resources in the UK, France and Germany over the coming years to accelerate EMEA sales. Management also mentioned new product registrations in the Middle East (Saudi Arabia, Kuwait, Qatar and UAE) and is working towards distribution agreements for those countries. In Japan, we see a lot of positives in Nanosonics choosing Sakura Seiki as partner. Theoretically, the Japanese Trophon market could be as large as the US market but we model half that level (2000 Trophons/annum) as a peak growth sales target in our model. Japan still has a way to go in developing a framework of guidelines for high-level disinfection. We do not factor any sales from Japan in our FY18 forecast but do model a launch in early FY19. Page 3

4 Cash flow and balance sheet Operating cash flow improved markedly to $16.4m and was better than our forecast of $15.2m. Note that we do not expect Nanosonics to pay cash taxes until FY21 having closed FY17 with accumulated losses of $37m. Balance sheet Nanosonics increased its cash holdings by $14.2m in FY17, closing the period with a strong balance sheet: $61.6m net cash. Nanosonics is fully funded to pursue its international sales growth campaigns and new product R&D. Page 4

5 Outlook and earnings forecasts Model changes Key changes in the model for FY18e and FY19e are as follows: Moderated US Trophon sales forecasts. Management indicated that demand patterns in 1H18 are similar to those in 2H17. We model 3,850 US Trophon sales in FY18 and 3,925 in FY19e. From that point in the model we recognise an uplift. We have two drivers in mind: a) prospect of a second generation Trophon; and b) the new Capital Reseller agreement that comes into force between Nanosonics and GE Healthcare from FY20 (announced late last week). Under this revised deal, Nanosonics will take responsibility for consumables sales across the GEHC customer base, providing a material uplift in consumables mix and gross margin. EMEA forecasts re-wired for Managed Equipment Service (MES) contracts. This was a major change in the model, backing out Trophon sales from our revenue forecasts and replacing them with a back-ended contribution from higher: a) volume; and b) consumables pricing. Depreciation forecasts are also increased as a result (included in COGS, each device s manufacturing costs recognised over a five-year period). At this stage we have only made very modest changes to the installed base growth rate in the UK but recognise potential upside to consumables forecasts in the event the MES approach proves a useful catalyst for increased adoption. R&D investment up very significantly. Management indicated $14m in its FY18 budget for R&D which was $4.7m higher than our previous forecast. We have sustained a similar level of R&D over the forecast period and this is a major driver of our EBITDA revisions. SG&A expense guidance. Management expects $34m in FY18 which was $5.1m higher than our forecast. Combined, Nanosonics expense guidance was $9.8m higher than forecast. Table 2: Summary of forecast changes FY18 FY19 Sales revenue - Before $m Sales revenue - After $m Change % -7.1% -14.4% EBITDA - Before $m EBITDA - After $m Change % -64.2% -52.2% NPAT (normalised) - Before $m NPAT (normalised) - After $m Change % -66.4% -45.0% EPS (normalised) - Before cps EPS (normalised) - After cps Change % -66.1% -44.7% Source: Wilsons estimates Page 5

6 Table 3: Divisional earnings forecasts FY16-24 ($ in mn) FY16 FY17 1H18 2H18 FY18 FY19 FY20 FY21 FY22 FY23 FY24 USA APAC EMEA Medical device revenue pcp device growth 57% 6% 19% 12% 22% 19% 19% 24% 22% 6% COGS Gross profit SG&A R&D EBITDA D&A EBIT (0.4) Net interest Pre-tax profit (0.3) Tax Normalised NPAT (0.1) Normalised EPS (0.0) Diluted shares Operating cash flow Gross margin 75% 73% 71% 73% 72% 72% 71% 71% 71% 71.0% 72.0% SG&A 59% 40% 43% 47% 45% 39% 35% 32% 28% 25.3% 26.0% R&D 17% 14% 17% 20% 19% 16% 14% 13% 8% 8.0% 8.0% EBITDA margin 2% 21% 14% 8% 11% 19% 24% 28% 36% 39% 40% Source: Nanosonics, Wilsons estimates Page 6

7 Nanosonics (NAN) Business description Nanosonics develops, manufactures and markets equipment for the high level disinfection of ultrasound probes and other pieces of medical device hardware. Its products are underpinned by a NanoNebulant technology very fine, nebulised droplets of concentrated hydrogen peroxide which kill microorganisms on surfaces. Its lead product, the Trophon EPR, is now available in most major markets for disinfecting obstetrics/gynaecologic probes. Investment thesis We maintain our BUY rating with a revised price target of $3.10 per share. Nanosonics FY17 results were broadly in line, reporting normalised NPAT of $13.9m and strong cash generation. Management signalled the start of a new investment phase to accelerate growth in Europe, target market development in Japan and the Middle East and launch at least two new products over the next two years. The outlined investments significantly reduce our short-term earnings forecasts. Importantly, the US business remains in growth phase, providing both the stability and capital to push Nanosonics intellectual property assets harder and through to their full potential. Nanosonics remains on Wilsons Conviction List. Revenue drivers Has an non-exclusive distribution arrangement with GEHC for the US and Canadian markets Network of third-party device distributors in Europe Revenue a function of both device sales (capital equipment) and consumables (cartridges of hydrogen peroxide and other products used with every disinfection cycle) Margin drivers Gross margins: devices (c.60%); consumables (c.85%) Contract pricing may be variable Business development expenses expected in both Europe and USA business building channels, increasing awareness, providing additional customer support Key issues/catalysts Upside risks: Faster-than-expected sales traction in USA and other markets Decision to scale-up manufacturing a leading indicator of demand New product development opportunities may include high-level disinfection units for transesophageal transducers, endoscopes or other device reprocessing applications Risk to view Downside risks: Lower sales growth Regulatory and/or clinical practice changes take a long time to change All device manufacturers face scale-up, quality control risks. Balance sheet Nanosonics had c.$61m net cash as at end-fy17 Board Mr Maurie Stang (Non-Exec. Chairman) Mr Michael Kavanagh (Managing Director) Mr Richard England (Non-Exec. Director) Dr David Fisher (Non-Exec. Director) Ms Marie McDonald (Non-Exec. Director) Mr Steven Sargent (Non-Exec. Director) Management Mr Michael Kavanagh (CEO) Dr Ron Weinberger (President Technology Development) Dr Steven Farrugia (Senior VP, Design and Development) Mr McGregor Grant (CFO) Mr Gerard Putt (COO) Contact details Address: 14 Mars Road, Lane Cove NSW 2066, Australia Phone: Website: Page 7

8 Disclaimers and disclosures Recommendation structure and other definitions Definitions at wilsonsadvisory.com.au/disclosures. Disclaimer This document is being supplied to you solely for your information and no action should be taken on the basis of or in reliance on this document. Any advice contained in this document is general advice only and has been prepared by Wilsons without taking into account any person s objectives, financial situation or needs. Any person, before acting on any advice contained within this communication, should first consult with a Wilsons investment adviser to assess whether the advice within this communication is appropriate for their objectives, financial situation and needs. Those acting upon such information without advice do so entirely at their own risk. Wilsons has not independently verified all of the information given in this document which is provided at a point in time and may not contain all necessary information about the company or companies covered in this report ( Companies ). Accordingly, no representation or warranty, express or implied, is made as to the accuracy or completeness of the information and opinions contained in this document. To the fullest extent permitted by law Wilsons, its related bodies corporate and their respective officers, directors, employees or agents, disclaim any and all liabilities for any loss or damage howsoever arising in connection with the use of this document or its contents. Any projections contained in this document are indicative estimates only. Such projections are contingent upon matters outside the control of Wilsons (including but not limited to economic conditions, market volatility and company-specific fundamentals) and therefore may not be realised in the future. Past performance is not an indication of future performance. This report does not constitute an offer or invitation to purchase any securities and should not be relied upon in connection with any contract or commitment whatsoever. Wilsons and Wilsons Corporate Finance Limited (ABN : AFSL ) and their associates may have received and may continue to receive fees from the Companies in relation to corporate advisory, underwriting or other professional investment services. Please see relevant Wilsons disclosures at wilsonsadvisory.com.au/disclosures. Neither Wilsons nor its research analysts received any direct financial or non-financial benefits from the Companies for the production of this document. However, Wilsons research analysts may attend site visits and/or meetings hosted by the Companies. In some instances the costs of such site visits or meetings may be met in part or in whole by the Companies if Wilsons considers it is reasonable given the specific circumstances relating to the site visit or meeting. Wilsons advises that at the date of this report, its directors, associates and employees may have relevant interests in the Companies. Wilsons and its related bodies may trade securities in the Companies as principal. Wilsons contact Phone: Website: wilsonsadvisory.com.au. Page 8