GH - Guardant Health: A Growth Company Expanding Its Product Line Quickly

2023-07-10 18:14:50 ET

Summary

• Guardant Health's share price has been volatile over the past year, but with strong clinical volume growth, the company presents an interesting investment opportunity.
• The company has diversified its revenue streams with new innovations such as the "Shield" blood test screener for colorectal cancer and the Guardant360 Response, which recently got approved for Medicare coverage.
• Despite negative net margins, the company is expected to lower operating expenses in 2023 and generate its first-ever positive EPS report by 2027.

Investment Outline

The last 12 months have been hectic and volatile for the share price of Guardant Health, Inc. ( GH ). Seeing as they are yet to have a positive bottom line, the hopes of new market opportunities and approvals are the main driver behind much of this share price volatility. Nonetheless, the company is trading a fair bit below its 52-week high of $62.75 per share, and with strong clinical volume growth, the company seems like an interesting investment opportunity right now. Momentum is building, and I don't think we should be waiting too long to get in.

Guardant operates as a precision oncology company that offers blood tests, data sets, and also analytics internationally, but the main operations are within the United States. Guardant is steadily increasing the number of revenue streams it has with new innovations, and a noticeable one recently was about "Shield", a blood test screener that GH has developed meant for colorectal cancer. The submission was made to the FDA on March 10 and marks another step for GH to diversify its portfolio of offerings. The strong momentum is visible so far and that GH can leverage this into revenue growth and operating expenses improvements make me confident to rate the company a buy now.

Recent Developments

The company has made steady progress in diversifying its streams of revenues, and the recent submission to the FDA for its blood test screener "Shield" marks another move to establish itself in the market in my opinion.

But GH has had other positive news released recently. The Guardant360 Response got approved for Medicare coverage. After the decision, the Guardant360 is now covered for fee-for-service Medicare patients in the U.S.

• Guardant Health, Inc., a leading precision oncology company, announced today that Palmetto GBA, a Medicare administrative contractor for the Molecular Diagnostics Services program (MolDX), has conveyed coverage for the Guardant360 Response test. Guardant360 Response is the first blood-only test that enables doctors to track molecular response through changes in circulating tumor DNA (ctDNA) levels, to get an early indication of metastatic or advanced cancer patient response to immune checkpoint inhibitor therapy.

The increased coverage ensures that the product that GH has reaches more people, but it also proves that GH has a role to play in the market. Developments like this reassure me that GH will continue to grow and expand at a satisfactory rate in the coming several years.

Margins

In terms of margins for GH, it's not much to brag about right now. The net margins are far down in the negatives, but improvements are being made and GH expects the operating expense to be lower in 2023 than in 2022. As a reference, the operating expenses for 2022 were $837 million.

Investing in GH is for the long term, and seeing major margin improvements on a quarterly or yearly basis just seems unlikely. Instead, I find it more important to see that the company is continuing to push out new offerings on the market while staying innovative. The earnings estimates for GH right now are that they will generate their first-ever positive EPS report in 2027.

The market for blood testing is growing at a steady pace and so far GH has been able to outperform it, given last quarter showed a 34% YoY growth in revenues. But GH of course has the challenge ahead of actually translating that growth into positive net margins. If GH stopped spending capital on research and development, the EPS for Q1 FY2023 would land at negative $0.39 compared to -$1.3 which was the actual result. This shows the impact currently that this spending is having on the bottom line. But what I find to be a reassuring factor here is that even if R&D expenses rose 14% YoY, the revenues still outgrew them. That together with a $937 cash balance leaves GH with a runway that extends until 2026.

Valuation

In terms of a valuation of GH right now, it's very difficult to justify one based on current results. One has to instead look forward and base the assumptions on GH continuing to grow rapidly and deliver strong YoY growth for the topline, as well as the bottom line.

Looking at the chart above, it bases the estimates on GH being able to keep up revenue growth of 25% each year, which is below what they have done historically. The 5-year revenue growth is 44% yearly. But I think it's important to be careful with estimates here, especially since GH has never been able to post a net income. If we look at the p/s it would be below that of the healthcare sector by 2026. Currently, the sector has a p/s of 4.16. That isn't to say GH would be an undervalued play right now based on that. But it highlights that GH is estimated to significantly improve its revenues. It's the momentum that justified the valuation for me in all honesty. But I think the R&D expenses are going to make a lower portion in regard to the revenues. Seeing as R&D accounts for almost half of the operating costs, my estimation suggests that the growth of revenues will lead to a better operating income and in turn better net income results as well. Based on today's price of around $37 I think that GH offers investors a growth opportunity in an exciting but very important market in the healthcare sector.

Risks

The risks that GH presents to investors right now are primarily around not maintaining the momentum it has had so far. Facing regulatory challenges or negative results for approval could create roadblocks for GH in its current growth trajectory.

But competition from other more established brands like Abbott Laboratories ( ABT ) could become an issue for GH. As we have talked about here, the R&D expenses make up a significant portion of the operating expenses, and ABT has come farther ahead here. For ABT, the R&D expenses are around 18% of the total operating expenses, whereas for GH it's 44%. In the early stages of a company like GH this is perfectly normal, but what would be increasingly more important to see is that it makes up a lower portion and that would prove scalability for the business model that GH has. A failure in showing that could be support for a lower multiple and valuation of the share price.

Investor Takeaway

Guardant Health is a company specializing in blood tests and analytics. As a precision oncology company, the company has a large market to tap into. The blood testing market is estimated to be valued at over $130 billion by 2028, representing a 7.63% CAGR between now and then. So far GH has managed to outpace this by a large amount as revenues grew 34% in the last quarter.

In most cases, with new companies like GH, the net margins seem to more often than not be negative and that holds for GH. I think that to be able to rate it a buy as I have done, one has to look at the momentum the company has. The company is also getting some tailwinds from new coverage like the "Shield" product in the Medicare program. Guardian Health is a long-term play, and right now, I think it's a good idea to get in.

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