ATRI - Atrion Corporation: A Curious But Concerning Selloff

2023-11-16 16:28:03 ET

Summary

• Atrion Corporation's share price has fallen significantly since the summer due to declining operating performance and inventory issues.
• The company manufactures niche medical products and has seen modest revenue growth in recent years.
• Despite the current challenges, the stock is trading at a more reasonable valuation, but more information is needed to assess the nature of the issues.

Atrion Corporation ( ATRI ) is a name which I last covered towards the end of 2020. At the time, witnessing a correction in its share price, amidst a booming market at large, I felt compelled to provide a look at the stock.

With ATRI shares lagging at the time, shares have seen resilient price action during the post-pandemic era which followed, but have fallen precipitously since this summer as operating performance has fallen off a cliff this year. While inventory and supply chain issues are cited as reasons, it feels as if there is more at hand here, making investors cautious, but providing potential opportunities as well.

Niche Medical Product Business

Atrion manufactures products in niche segments within the medical products' sphere, including contact lens disinfection cases, vacuum relief valves, clamps and minimally invasive surgery equipment. Outside of medical applications, the company uses its expertise in valves (among others) in marine and aviation settings.

The company has been a listed business since the 1980s, and as a $150 stock in 2010 saw a spectacular run to $900 in 2019, after which shares fell to the $600 mark in the fall of 2020.

These share price achievements should be seen in the light of a roughly $100 million business in 2010 which had steadily grown to a roughly $150 million revenue base in 2020, translating into a modest 4% average annual growth rate. Operating margins were steady around 25-30% of sales, although that margins have gradually come down a bit.

A share count of 1.9 million shares granted the company a $1.15 billion equity valuation at levels around the $600 mark late in 2020, including a roughly $100 million net cash position. This still resulted in demanding multiples, with operating assets trading at 6 times sales and 27 times earnings. That still felt a little too rich given the somewhat underwhelming revenue growth.

A Downfall

Since late 2020, shares have largely traded around the $600 mark in the period 2021 and 2022, in fact all the way up to June of this year. What followed was a huge pullback, with shares now down to $290 per share!

In February of this year, Atrion reported its 2022 results, and the company has seen modest and continued growth. After revenues grew to $165 million in 2021, revenues grew another 11% to nearly $184 million in 2022, as operating profits of $40 million rose in tandem. Diluted earnings were reported at $19.56 per share, as net cash balances of $34 million have come down amidst continued buybacks which reduced the share count to 1.8 million shares.

In May, Atrion posted a bombshell first quarter earnings report, with sales falling from $47.1 million this time in 2022 to just $40.0 million. While the company believed that it did not lose any big customers, it cited deliveries being pushed out by many customers, which it attributed to inventory levels normalizing. Amidst the pullback in the results, net earnings plunged some 60% to $3.5 million, equal to $1.98 per share.

Second quarter sales were reported at $43.8 million, and while they were down substantially from a $48.9 million number in the second quarter in the year before, revenues were up on a sequential basis. Net earnings fell some 30% to $6.5 million, with earnings reported at $3.73 per share. This time, the company cited supply chain issues as well, with shares falling to the $500 mark upon the release of the results, in part as net cash holdings were dwindling amidst reduced earnings and some buybacks.

To please investors, the company upped the dividend by five cents to $2.20 per share in August, and although the hike was minimal at 2%, yet payout ratios were increasing rapidly amidst the reduced earnings power.

In November, Atrion posted third quarter results with revenues of $41.9 million being down in a more moderate fashion from a $44.6 million number in the third quarter of 2022. The 6% revenue decline looks favorable compared to a 15% fall in first quarter sales and 10% decrease in second quarter sales, with the company continuing to cite inventory de-stocking efforts of the business and supply chain issues in other parts of the business.

Operating earnings were down in a more pronounced manner, down 60% to $4.1 million, attributed to production stoppages, designed to shrink inventory levels. These inventory levels have risen to $82 million, which is quite a large number and quite a large absorber of cash, which is down to $14 million here.

And Now?

The 1.76 million shares of Atrion have fallen to the $280 mark, reducing the market value of the firm to $490 million, or even a bit lower if we factor in net cash. Based on a revenue rate of around $175 million, sales multiples have fallen to less than 3 times sales here, which is low for a medtech player. While the growth is perhaps underwhelming, the business has long displayed on superior and impressive operating profits.

The real question is, whether market conditions, including elevated inventory levels, are the real reason for the softness. Certainly, this argument has been used for some quarters in a row now. Or, in the alternative, whether there are self-inflicted and performance issues. Following the cadence of last years, this should in theory be a nearly $200 million business, which would be perfectly capable of posting operating profits of $50 million, and should support earnings per share of $20-$25, which would make current levels of $280 look like at steel at 10-14 times earnings.

The issue is that this is not achievable here anytime soon. While long-term growth had been a bit underwhelming, it is the current shortfall in sales and margins which raises real questions whether there are more developments at hand here, with shares now back to levels last seen a decade ago!

A Final Word

Right now, current Atrion Corporation levels look rather compelling at 10-14 times normalized earnings (as if the company would have continued its growth trajectory), and this comes after the company has long traded at a premium multiple, perhaps too much of a premium given the modest growth pace in the past.

The issue is that current woes cannot be seen in isolation to inventory issues, but some structural headwinds appear to have been going on here. This means that earnings could be subdued in 2024 as well, but the real question is what is really happening under the hood.

Nonetheless, overall Atrion Corporation valuations look a lot more reasonable here, but information provision is relatively modest, leaving investors somewhat in the dark with regard to the nature of the issues. Amidst all of this, I would be willing to consider going small on a speculative basis here, with a greater position only justified as more news is release here.

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