DSRLF - DiaSorin: Overvalued Italian Healthcare Company

Summary

• DiaSorin S.p.A. is an Italian healthcare company that develops, produces, and sells reagent kits and analyzer instruments mostly used to detect patients’ diseases.
• DiaSorin benefited from the outbreak of the covid pandemic which heavily increased the number of diagnostic tests carried out to track the spread of the pandemic.
• Despite being expected to maintain great efficiency and profitability, DiaSorin doesn't represent a good investment opportunity given the expected reduction of covid tests.

Investment Thesis

While most companies around the world suffered because of the covid pandemic, DiaSorin S.p.A. (DSRLF), an Italian healthcare company, registered double-digits growth rates thanks to its diagnostic testing kits used to detect covid infections and other diseases.

DiaSorin's revenues benefitted from the crazy amount of tests carried out around the globe in the past two years, but with the covid pandemic becoming more and more a distant memory, we cannot assume the company will maintain these growth levels.

Despite being expected to maintain great margins and returns on capital, at today's price, DiaSorin's stocks is overvalued if compared to an intrinsic value of €78 per share. That's under the assumption of more modest growth as the company's business model returns to pre-pandemic standards.

In today's analysis, we will assess why DiaSorin does not represent a good investment opportunity given the expected future development of its business model.

Business Model

DiaSorin develops, produces, and sells reagent kits and analyzer instruments mostly used to detect patients' diseases. In particular, its products are made for the immunodiagnostic and molecular diagnostic markets and are used in the fields of infectious diseases, oncology, and endocrinology.

After the acquisition of Luminex in 2021, DiaSorin, other than strengthening its presence in the molecular diagnostic industry, obtaining access to multiplexing diagnostic technologies, also entered the Life Science market, expanding the company's future opportunities.

Geographically, North America accounts for the majority of revenues, at 39%, followed by Europe at 26%. While on a product's type basis, Immunodiagnostic reagent kits account for almost 50% of total revenues.

Starting in 2020, DiaSorin started to include covid test-related revenues, accounting for 30% of total revenues in 2020 and 2021.

Operating Performance

Looking at DiaSorin's past operating performances, revenues grew at a compound annual growth rate ((CAGR)) of 12.36%, from €433 million in 2012 to €1.23 billion in 2021, and are expected to remain around €1.27 billion in 2022.

However, the performances of the last two years were severely influenced by the outrageous number of covid tests undertaken to keep track of the covid pandemic spread. If we depurate DiaSorin's revenues from covid-derived revenues, in 2021 revenues were actually equal to €859 million, equal to a CAGR of 7.9%.

For the 2022 fiscal year, the management expects covid test revenues to be equal to €225 million, significantly lower if compared to the past two years, but easily comprehensible considering that the pandemic is basically over in Western countries. With that in mind, 2022 total revenues ex-covid are expected to be equal to €1 billion.

Moving on to past operating margin and return on invested capital ((ROIC)), DiaSorin achieved great efficiency and profitability through the years, having a median 5-year operating margin of 31% and a median ROIC of 24.5%.

Thanks to such strong performance, excluding 2021 when the acquisition of Luminex took place, DiaSorin delivered solid and consistent free cash flows to the firm ((FCFF)).

Financially, despite having a negative net cash position of -1€ billion due to the loan and convertible bonds issued to finance Luminex's acquisition, DiaSorin is solid with a current ratio of 3.12, a debt-to-equity ratio of 0.87, and in particular, an interest coverage ratio of 13.06, meaning that the operating income covers the interest expenses 13 times.

Growth Drivers

DiaSorin's business model is based on continuous investment to develop and improve existing reagent kits, therefore, R&D expenses represent its main growth driver for future growth. Acquisitions also play an important role in driving the company's future success, permitting DiaSorin to access new technologies and enter new markets as happened with Luminex's acquisition.

Future growth can be determined by looking at how much and how well a company has invested in its growth drivers. The Reinvestment Margin shows what percentage of revenues has been reinvested into the company, while the Sales to Invested Capital ratio, shows how much revenues have been generated for each dollar invested by the company. If we multiply these two values and take the median value over the years, we obtain the expected growth rate in revenues based on how much and how well a company has invested in its growth drivers.

In our case, DiaSorin's expected growth rate is 15.5%.

Market & Risks

The global diagnostic market is expected to double in value by 2030, growing at a CAGR of 8.63%. The outbreak of the covid pandemic surely has been a major driver for the further expansion and adoption of diagnostic test kits to detect illnesses, however, as regards DiaSorin we cannot assume the company to keep benefitting from covid-tests related revenues.

In 2020 and 2021 covid revenues accounted for more than 30% of total revenues, but as the pandemic fade away in the U.S., UK, and European countries, we can expect covid tests to diminish till the point they are no longer needed. When this happens, DiaSorin should lose a consistent portion of its revenues, with an inevitable cascade effect on its operating performance.

DCF Model Analysis

I use the discounted cash flow ("DCF") analysis method to value companies. The aim of a DCF analysis is to determine the present value of expected cash flows generated by the company in the future. The first step is to project the growth rate at which revenues will grow in the future. Secondly, we will need to assume the degree of efficiency and profitability at which the company will turn revenues into cash flows.

Efficiency is represented by the operating margin, and profitability by the ROIC. Having the revenue projections and future operating margins, we obtain the EBIT and, after subtracting taxes, we get the net operating profit after taxes. The ROIC is used to determine the reinvestments needed to support future growth, determining how much profit the company generates from every dollar reinvested into the company.

Future cash flows are calculated by subtracting the reinvestments from the net operating profit after taxes. The higher the growth rate, the higher the reinvestments needed to support it, hence the lower future cash flows will be.

The last step of a DCF analysis is to apply the discount rate to future cash flows, usually calculated using the weighted average cost of capital ('WACC').

Projection

Now trying to project DiaSorin's future performance, we will assume covid related revenues to disappear as they are no longer required, especially in developed countries. At the same time, we will assume DiaSorin to benefit from the acquisition of Luminex, delivering strong growth in the near future, and maintaining high margins and returns on capital as it has done in the past.

Starting with revenues, to eliminate the influence of covid related revenues from our projection, as a base to calculate 2023 revenues I've used the ex-Covid revenues expected for the 2022 fiscal year, equal to €1.05 billion, instead of the total expected revenues of €1.27 billion.

With that said, we can apply the expected growth rate of 15.5%, based on how much and how well DiaSorin has invested in its growth drivers, and let it slowly decline as the company reach maturity. Revenues are expected to almost double in 10 years reaching €2.2 billion at a CAGR of 5.85%.

As regards future operating margins and ROIC, we can expect DiaSorin to maintain its historical value, respectively being around 30% and 25% by 2032, assuming the company will maintain its relevant position in the industry. The diagnostic industry is not barrier-free, with companies having to develop cutting-edge technologies to be able to compete, and doing so requires considerable time and money.

With these assumptions, DiaSorin will deliver solid and consistent FCFF expected to be around €450 million by 2032.

Valuation

Applying a discount rate of 9.11%, calculated using the WACC, the present value of these cash flows is equal to an equity value of €4.18 billion or €78.3 per share.

Conclusion

Given my analysis and assumptions, the DiaSorin S.p.A. stock result is to be overvalued at today's prices.

DiaSorin is surely a great company, with an excellent business model, that even without benefiting from the covid pandemic, is able to generate high returns, however, the market is currently paying a premium for such performances and that doesn't make DiaSorin S.p.A. a good investment opportunity.

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