DXCM - DexCom: Fantastic Growth But A High Premium To Pay Right Now

2023-07-06 13:03:01 ET

Summary

• DexCom's share price has increased by 414% over the last five years, driven by the company's innovative continuous glucose monitoring systems.
• Despite a high price-to-earnings ratio, the company has recently revised its 2025 growth targets upwards by 13% to $4.6 - $5.1 billion.
• I consider the company's shares a hold currently rather than a buy due to the risk of a significant drop in valuation if DexCom cannot maintain its current growth momentum.

Investment Outline

Looking at the stock chart over the last 5 years for DexCom ( DXCM ) one has to be a little impressed at least. In that period its share price increased by 414%, growth fueled by the innovative products the company is making - i.e., continuous glucose monitoring systems, or CGM systems for short. Despite revenues having increased by 4x in the last 5 years, DXCM is still posting impressive results. T he Q1 report for FY2023 included a 19% organic revenue growth in comparison to Q1 FY2022.

One has to realize that this sustained growth has been the cause for the massive return the share price has had over the years and the reason for the rich premium you have to pay for DXCM. The company recently reiterated its growth targets for 2025 which now sits at $4.6 - $5.1 billion, an upwards revision of 13%. The momentum is what carries DXCM forward right now and by 2025 the P/E would be at 66, far down from the 118x it is trading at now. That is what investors are looking for: that DXCM can maintain this momentum. But this also presents a substantial amount of risk to investors, since if DXCM can't maintain the momentum, then a significant compression in valuation will have to occur to reflect this. I find that risk enough to not warrant DXCM a buy right now, but rather a hold instead.

Business Overview

DexCom focuses on the design and development of continuous glucose monitoring systems. The product is aimed at people who have diabetes but also for healthcare providers as a means of monitoring their patients efficiently.

The rise of diabetes type 2 has significantly increased over just the last two decades. The rise has been very noticeable in the United States and by 2060 the projections suggest that over 220,000 young people will be diagnosed with type 2 diabetes. This would reflect a near 700% increase from today's numbers. Diabetes type 1 remains the most common one in the US among youths but the rise of type 2 is concerning.

Where DXCM enters the picture is through its highly advanced monitoring systems which have proven to significantly increase the quality of life for people diagnosed. It has been seen to reduce stress and eliminate the need for fingersticks. Apart from this, it also protects against hypo / DKA. But another major benefit to it is the costs that users are saving. In the US, the annual cost for people with diabetes was $20,000 . For many people, it's a challenge to be able to pay this amount, which makes the need for CGM to gain broader acceptance such an important issue.

Recent Developments

What caught most investors' attention recently with DXCM has to be the significant increase they made to their 2025 growth targets.

The management made this revised guidance as a result of the surprisingly strong performance the company had in the first two years of the target period. The CEO Kevin Sayer had some notes on the announcement too, “Our growth opportunity is truly unique and we are pleased to be in a position to raise our 2025 financial targets as we grow our global customer base with an efficient and sustainable business model”.

My view on this is that the broader market access that CGM has had is the result of this increase. The potential of reducing patients' costs efficiently is visible with the product that DXCM has. Inpatient admission costs have been shown to be reduced by 35% and inpatient visits reduced by 50%. This speaks volumes about the quality of CGM systems offered.

Margins

In terms of margins for DXCM, they have seen strong improvements over the last few years and are above its 5-year averages a fair bit. The TTM net margins are 9.68%, a 33% positive difference from its 5-year average of 7.25%. Supporting my claim that DXCM will continue to see margin expansion is the growth seen not just in the US but also internationally. The international revenues for DXCM were up 21% during Q1 FY2023.

With a strong operational performance to the start of 2023, the management raised guidance for the year and sees the Adjusted EBITDA Margin landing at 26%. As the DexCom G7 is becoming the new standard in terms of CGM technology the company has an easier time expanding internationally, which they recognize to be a major market opportunity. The launch of G7 in several major markets like the United Kingdom and Germany has been a cause for international revenue growth and is making a larger portion of the total revenues than a year prior. In regards to margins, I think expansion like this could mute margin growth in the short term, but long-term it will be very beneficial as DXCM can establish its product in key markets. This can then be leveraged and turned into expanding margins.

Value For Investors

In terms of the value that investors are getting here, it seems to have been enough historically to just hold onto shares as they are up over 400% in the last 5 years. As far as a dividend goes with DXCM, I think it is way too early to establish one, seeing as the company is still in its growth phase, and the announcement of a dividend could indicate them seeing growth halting. That would ultimately result in a significant share price drop, I think.

What I find intriguing however and further bolsters my hold rating for DXCM is the fact that shares outstanding are decreasing on a YoY basis recently. Falling by around 2.3% is for me a rather bullish signal that EPS growth will be strong and that the management has a focus on returning value to shareholders when they can.

Valuation

What is a major concern for many people interested in DXCM right now is the sky-high p/e it has at over 110x on an FWD basis. This should start making alarm bells ringing for anyone. But what we can blame for this valuation is the incredible track record that DXCM has had so far in terms of revenue growth.

Above the model highlights the discrepancy between the current share price and what I found to be the intrinsic value. As for FCF growth, I estimate 15% yearly growth, which is lower than what the historical growth has been, but it's all in the name of having somewhat realistic expectations for a company with a not-so-reasonable valuation. When it comes down to it the intrinsic value is $4.2 per share. With a 20x multiple, however, which should be fitting seeing as DXCM is still a growth company the target price lands at $84 per share, still around 30% under today's share price. Which would indicate you are paying a 30% premium for the current share price. That highlights why I wouldn't be able to make DXCM a buy just yet. It would need to come down to that level to make it appealing as an investment. Without the debt and cash accounted for the intrinsic value would be $6.6 per share, and with a 20x multiple a target price of $132, which is above the current price.

Risks

Competition is a major risk to DXCM. Some notable companies that are also involved in making CGM systems are Medtronic ( MDT ) and Abbott Laboratories ( ABT ). These two giants themselves give DXCM a run for its money.

So far however, the leading position in the CGM industry still belongs to DXCM with MDT in second place and ABT in third. It should be mentioned that the larger competitor of the two is MDT as ABT so far doesn’t hold a significant enough market share to justify it as a large competitor.

Apart from the competition, the risk of the valuation compressing as growth is slowing down eventually could lead to bag holders being left with DXCM shares. If DXCM was to have a p/e of 20 which is the same for its sector, then the share price would land around $23 - $24 using the 2023 EPS estimate of $1.09. That represents a nearly 80% decrease from today's levels.

Investor Takeaway

What DexCom has is an incredibly valuable product that serves a broad market and a somewhat unfortunate reality is that the market is growing also, as the number of people diagnosed with either type 1 or type 2 diabetes is expected to increase in the coming decades. Nonetheless, what DXCM does is make the lives of people with diabetes easier and also helps them cut down on healthcare costs.

The growth of the business has been immense in the last few years, and this has been reflected in the share price as well. Up over 400% in the last 5 years some might wonder if the time to buy has passed and well, in my opinion, I don’t think it has - the time just isn't right now. The valuation needs to come down a fair bit to start a position more appealing. Somewhere around the $70 - $80 is where I would be looking to buy if we ever reach those price ranges. For the moment however I think that DXCM is a hold, the future potential is too good to pass up on and not be a part of; however, I think it's not unreasonable to expect a significant drop in the share price if DXCM faces some short-term headwinds.

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