EMBC - Embecta: Slow Growth Shows Why The Valuation Is So Low

2023-07-23 05:56:37 ET

Summary

• Medical device company Embecta's share price has decreased by over 21% YTD in 2023, despite a growing market for diabetes solutions.
• Embecta has partnered with Tidepool to develop an automated insulin delivery system for type 2 diabetes, but clearance from the FDA is still needed.
• The company's high long-term debt and slow growth make it a risky investment, despite a persistent demand for its products in the healthcare sector.

Investment Outline

Embecta ( EMBC ) has been in business for a long time, all the way back to 1924. Today it operates as a medical device company that focuses primarily on various solutions which aim to enhance the health and well-being of people diagnosed with diabetes. More people are expected to be diagnosed with diabetes in the coming several decades and that will ensure that EMBC has a market to service.

But this outlook for a growing serviceable market hasn't been reflected in the share price. The market has been very pessimistic about EMBC recently and the share price has decreased over 21% YTD in 2023. The FWD p/e sits at just 7 and with a 3% dividend yield one might question what the downside potential from here on out is. For me, it's the lacking revenue growth that is justifying the low multiple right now. With revenues just growing 4% constantly EMBC isn't a growth company and with a small market cap, it lacks some of the capital resources to make acquisitions to drive growth that way. Rating EMBC a hold now.

Recent Developments

Back on May 12, 2023, EMBC announced that they have entered into a partnership with Tidepool to develop an automated insulin delivery system for people diagnosed with type 2 diabetes. Tidepool is also a company that focuses on improving the quality of life for people who suffer from diabetes. Seeing as these two are some remarkable players in the industry a partnership together should bring innovations.

The CEO of EMBC Devdatt Kurdikar said the following about the partnership, “By partnering with Tidepool and tapping into their expertise on AID software development, we’re continuing our effort to deliver a user-friendly patch pump solution that will make life better for people living with T2D”.

I don’t see this announcement as enough though to make EMBC appealing enough to invest. Perhaps it will add some new revenue streams, but until that ends up on the market is likely far away, and getting clearance from the FDA will also be necessary.

Margins

In comparison to the sector, EMBC has very good margins, and on it's they are very good I think. But the company is right now displaying that even if you have good margins that isn't enough to ensure a higher valuation. Net margins of 8.4% are great for the healthcare sector and I think given the market that EMBC are in it seems realistic to suggest that they will be able to maintain it.

What could be a weighing factor on the margins going forward is the fact expanding into emerging markets will likely be expensive, as the need to set up reliable shipping and supply routes will take time and capital. But it does present a lot of potential for more growth and in the long-term yield EMBC higher margins.

Value For Investors

As for the value that investors are getting right now with EMBC it seems to be primarily with dividends. The company has been slightly diluting shares in the last few years. There is also not any immediate upside potential from being undervalued in the sector, the p/e is still quite high.

The dividend is quite recent and hasn't been active for that long. For the moment the payout ratio is nearly 15%, and with FCF margins at 9.7%, I think this looks sustainable. The last 12 months have accumulated $25 million in dividend payments. Where I might see some risk is the fact that EMBC is paying a lot of interest expenses right now as a result of having newly signed $1.5 billion worth of debt. TTM the interest expense is $93 million. If margins falter and demand dwindles then seeing the dividend cut or dismissed for several quarters seems highly likely as EMBC will need to battle the mentioned expenses instead.

Risks

The debt that EMBC has gathered up during just the last couple of years is quite worrisome and puts them in a position where a lot of earnings will need to pay this down. I mentioned above here already that the interest expense where $100 million TTM.

That $100 million is around 8% of the total revenues that EMBC has had. After the cost of Revenues has been applied EMBC had $758 million left. Here 13% of the gross profits will be needed to pay down interest. That isn't a healthy position to be in, rather something around 5%. I find it likely that we will continue seeing a high internet expense as the debt was likely signed at higher interest rates and signed for a longer period. This will weigh on margins and if we have a quarter with disappointing results the share price will very likely decrease to a p/e around 12 - 14 instead.

Company vs Peers

For investors wanting to be in a company focused on treating diabetics and providing services for that market might want to look elsewhere honestly. DexCom ( DXCM ) is a massive company with a market cap of $51 billion. I have covered this company before and concluded that it was a hold. The appeal though of going with DXCM instead comes down to the sheer market share they hold and the fact they could easily buy out EMBC as well. Growth has been explosive for DXCM but is expected to continue as more and more people are diagnosed with type 2 diabetes.

Investor Takeaway

The valuation seems risky with EMBC right now as the growth seems slow and with a lot of long-term debt weighing on the company, less capital is available for strategic investments or potential acquisitions. The net debt/EBITDA ratio is quite high at 2.95, leaving little room for margins to compress. This risk is enough to suppress a buy case for EMBC right now I think. But given the market they are in it seems that demand will latest be persistent and that is worth a hold rating at least.

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