AIRS - AirSculpt Technologies: Growth Rates Expensive For Shareholders Looking Ahead Reiterate Hold

Summary

• AirSculpt Technologies has potential to be a niche operator in a crowded space of human plastics.
• Since listing, shares have crumbled, as investors re-rated the stock heavily to the downside.
• However, the re-rating looks more than justified, and we demonstrate that future growth from AIRS could come at a cost to equity holders.
• Net-net, we reiterate hold on the company's common stock.

Investment Summary

The body contouring business has been dubbed as a lucrative one, with the global market reaching a $7.8Bn size in 2022. It's expected to grow at a CAGR 6.81% over the coming 5-year period to $11.7Bn, with supplementary research pointing to an 14.3% CAGR into 2030. In either sense, there's been rapid adoption of new technology, new innovations, and corresponding product development in the space these past few years – each being key market growth drivers. Moreover, the broader plastic surgery market has its key differentiators, often free from CMS reimbursement overhang, and offering lucrative margins on capital equipment placements. Check out our coverage on Cutera, Inc. (NASDAQ: CUTR ) for more on this [click here ].

It's not all bells and whistles for individuals in the space though. Several publicly listed names have yet to prove themselves, and on that point, it's time to have an honest look at one of those today, AirSculpt Technologies, Inc ( AIRS ). We covered AIRS back in August last year, [see: here ] noting its niche and potentially differentiated offering, that was offset by profitability issues. Simply, unprofitable companies – defined here as negative net operating profit after tax – will continue to struggle adding shareholder value looking ahead in our opinion, amid a normalized rates policy, macro-level challenges, and a higher cost of capital.

AIRS weekly price evolution, 2021–date [log scale]

Note, AIRS listed back in 2021, amid the hype in public equity markets, where the cost of capital was also at record lows, and companies could raise equity capital at equally low costs. However, the company has yet to deliver on the chart, with shares down at CAGR negative 9% return since its listing date. Here I'll run through where AIRS needs to improve, explaining the rationale behind our hold thesis. Reiterate hold.

AIRS unable to generate value for equity holders

We'd remind investors that a firm can generate ongoing value for its equity holders when it generates a return from its investments higher than the cost of capital. Here, I'm going to ask you to forget accounting realities, and focus on the economic reality instead. If a company generates a return on invested capital ("ROIC") above the hurdle rate, this is known as economic profit ("EP"). A positive EP means a lower amount of post-tax earnings needs to be reinvested to generate additional growth, leaving more free cash leftover for shareholders. As such, EP is an integral measure to scrutinize to understand a company's valuation. Moreover, the value one can receive as a shareholder into the future.

Traditionally, we calculate ROIC and EP using tax-adjusted operating income. Given AIRS is yet to deliver on this, we've tweaked the equation slightly to look at its cash from operations ("CFFO") to see how much, and how well it's invested to generate growth in operating cash flow. Thankfully we have data heading back to 2019 to gauge a longer-term profile [Exhibit 1]. In the period from 2019 to the trailing 12 months, AIRS generated a cumulative $199.7mm in CFFO, leading to an additional growth of $7.2mm in operating cash flow.

Exhibit 1. AIRS CFFO summary, 2019–TTM

These aren't bad numbers on face value, and the company has certainly grown operations over that time. However, this doesn't tell us much about the quality of these cash flows – i.e., what kind if investment was required to generate them. Whilst AIRS generated $199mm in CFFO from FY19–TTM, it had to invest an additional $215mm in capital to achieve this. Consequently, it earned a woefully low return on incremental invested capital of just 3.34%. Note, this is lower than its WACC hurdle over the testing period [in Q3 FY22' it stood at 9.42%], hence, the economic reality is, AIRS generated an economic loss over this time. In other words, to generate the stipulated growth in CFFO, it had to reinvest more than 107% of its operating cash flows to achieve this, meaning that it grew at a compressed rate of ~3.6% over this time. A 107% reinvestment of CFFO to generate just 3.6% isn't attractive at all, in our estimation.

You'll remember earlier I mentioned that EP and a high ROIC is essential to generate shareholder value, because a smaller portion of earnings is required to reinvest for additional growth, leaving more for equity holders. Alas, the caveat to this is, when the ROIC is less than the hurdle rate [economic loss], any kind of growth is destructive to valuation, as the cash flows meant for us, the investors, must be reinvested back into the business. That could be worthwhile if the growth rate was, say, 50% – but for AIRS, it was just 360bps, as mentioned.

Hence, there's a negative balance on what we receive as shareholders, ultimately hurting the valuation of the AIRS share price. This matches up quite well to its market performance, as the distributable cash to shareholders is negative 7.8% over this time [1-107.8%], and it's share price has sunk at an annualized 9.14% since listing. In other words, it makes sense that the market has re-rated the stock to the downside.

Moreover, it makes valuation near impossible, because we are yet to see any free cash flows distributable to the common equity holders of the company.

Exhibit 2. AIRS yet to prove its stewardship in capital budgeting, with the growth of 3.3% coming at a cost of 107% for equity holders.

In short

We showed that AIRS' growth has been a negative for its valuation, given the negative spread of its ROIC to its cost of capital. This doesn't leave much in the realms of valuation. We'd also point out that AIRS also has preferred stock holders, and paid a dividend of $10.9mm to these investors last year. Remember, preferred equity holders sit above common equity holders in the capital structure, so this reduces the residual earnings even further. As such, value looks to be absent in the name for now, a key downside risk for investors. Consensus has the company to print a 28.7% YoY growth in revenue for FY22, and we'd argue this will come at a large cost to equity holders. This sentiment is supported by technically derived price targets obtained from our point and figure studies [Exhibit 3], where we have downside objectives to $3.70.

Exhibit 3. Downside targets to $3.70.

In our last report, we said: "...we are paying [the current market price] for a negative tangible book value and cash flows priced distantly into the future. With healthcare catching a serious bid in H2 FY22, there may be more profitable opportunities elsewhere for investors to budget equity risk towards". Now, add to this the fact that future growth for the company will come at a high price to equity holders, unless AIRS can demonstrate a higher return on invested capital from its operating cash flows. Hence, we believe there are more selective opportunities available elsewhere, that can offer this setup. Reiterate hold.

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