HOLX - Hologic: Additional Critical Factors Forming Bullish Thesis Reiterate Buy

2023-07-01 05:25:19 ET

Summary

• Hologic continues to present with attractive business economics and robust fundamentals ex-Covid.
• There are additional critical factors to consider, including positive sentiment and price studies.
• Investors look to be bullish on HOLX based on the culmination of studies presented in this report.
• Net-net, reiterate buy.

Summary of investment findings

Another reasonable period of growth from Hologic, Inc. (HOLX) in its Q2 FY'23 means there is no immediate change to my buy thesis on the company. Following my April publication on HOLX, the stock has pushed into congestion and tracked sideways, with a small turn to the upside after its quarterly numbers.

As a reminder, the reiterated buy thesis from April was predicated on the following factors:

1. HOLX possesses tremendous operating leverage, averaged 2x-2.6x operating leverage since FY'18 and FY'20. Hence, with 6% decline in sales projected this year, I still get to $1.4Bn in operating income in FY'23 forecasts.
2. It reinvested its "Covid-19 profits" wisely and has reduced its capital requirements to maintain its steady-state of operations.
3. Most importantly, the economic profits HOLX produces on a regular basis (defined here as ROIC less the defined hurdle rate of 12%) average 20-25% on a rolling basis, thus it can throw off tremendous piles of cash to its shareholders without jeopardizing growth of the business, and vice-versa. Incrementally, since September FY'21, this had equated to an 18% reinvestment of post-tax earnings to generate a 38% return.

Based on the investment findings, there is all reason to believe these trends will continue moving forward.

Turning to the latest numbers and there's been no change to HOLX's long-term trajectory in my view. Keeping this long-term framework in mind, my numbers have the company valued at $170-$173 per share, more than 100% upside on the market price as I write.

Whereas the last report centred on the company's economic characteristics, this analysis will hone in on the company's latest numbers and provide additional insights on sentiment and market-generated data. The spectacle is how investors are positioning in HOLX, and what the Street is saying on the stock in their revised targets. A long-term view will be maintained throughout. Net-net, I reiterate HOLX as a buy.

Figure 1.

Critical facts to reiterated buy thesis

Whilst I am reiterating the buy on HOLX for much of the same reasons as last time, there has still been a number of very important updates in HOLX economic profile that must be discussed at length. Starting with the firm's latest numbers (corresponding to its Q2 fiscal FY'23, the same as Q1 CY 2023)- these are telling. Two out of the firm's 3 divisions grew north of 25%, and it clipped GAAP earnings of $0.88 for the quarter, down from $1.81 the year prior.

The decline is expected, given the complete wind-back in Covid-19 revenues. As you'll see here, comparisons must be made with the firm's operating results with and without Covid-sales included.

1. Q2 FY'22 earnings dissection

First focusing on the firm's core divisions, when excluding Covid-related sales, diagnostics sales were up 14.9% YoY. This was powered by growth in molecular diagnostics turnover, increasing sales by 24% YoY itself. Surgical and Breast Health also delivered impressive performances, growing 25.2% and 25.7% to $385.4mm and $144.8mm, respectively.

Based on the numbers, I would also include the points below as divisional highlights for the quarter. Keep in mind, each number must be compared with Covid and non-Covid:

1. Including Covid-19 sales in the diagnostics segment, the segment's turnover declined 52% YoY.
2. As mentioned, molecular diagnostics revenues were a key driver to the ex-Covid sales. I would submit this is good evidence of HOLX's increasingly diverse portfolio of clinical and non-clinical assets, including, (a) newer assays, alongside (b) the legacy women's health portfolio.
3. Rounding out the quarter was the 53% growth rate in its skeletal business, printing $31.6mm in revenue.

In total, it booked $1.03Bn in quarterly turnover on a gross of 62.1%. It also repurchased 600,000 shares with a $50mm buyback, bringing its total to $150mm in buybacks this year to date. It left the quarter with $2.6Bn in cash, meaning and leverage of just 0.2x net-debt-to-EBITDA.

In that vein, the capital allocation opportunities for HOLX are quite abundant in my point of view. For one, it has $850mm still left authorized under its buyback program started back in September 2022. Based on its cash flows and cash balance, it will meet this number with ease. Presuming it maintains the cadence of purchases, you have a perpetually undervalued stock that HOLX will pay you a premium for, as long as the buyback is in situ.

Secondly, the firm's breast health segment is quite constructive in terms of opportunities ahead. On examination, I believe HOLX will be deploying capital at pace towards this division moving forward. For starters, chip availability is no longer a pertinent issue in getting volumes of HOLX's gantries out the door. Further, management report that demand for the firm's mammography instruments remains above average, and is very high. This is helped by the company's backlog that built over the pandemic era as well. Moreover, international breast health sales have normalized to previous range in the division. Collectively, it expects "healthy double-digit revenue growth compared to the prior year in Q3 and Q4" in its breast health division in FY'23.

In view of the divisional highlights, consider that there are many points for question and discussion.

• Based on the Covid-19 wind-down, you might have questions about HOLX's projections of 5%-7% through 2025- excluding Covid-19 sales.
• Based on language from the Q2 earnings call , the company firmly believes in the appropriateness of this target.
• Further, Q2 sales were ~$70mm ahead of guidance at the midpoint, indicating the firm's capacity to hit these growth percentages down the line.

Based on the objective findings within HOLX's guidance numbers and the momentum gained in Q2, it is of my view HOLX will clip $4-$4.1Bn at the top-line, ahead of management's $3.9-$4Bn guided range.

2. Sentimental factors

A clear bullish factor in the HOLX debate here is the uptick in sentiment that has spurred within the last 3 months of trade. Sentiment is measured in many ways these days-- anywhere from the news cycle, to retail capital flows, to social media.

One particularly effective way to gauge sentiment is via the progression of targets from analysts on The Street. For HOLX, this is telling. There have been no less than 14 upward revisions to revenue and 16 upward revisions to earnings to earnings over the past 3 months. This is a tremendous display of bullishness, with sell-side analysts now projecting a return to top-line and earnings growth from FY'24 for the company. That analyst targets have been raised 14 and 16 times in one quarter respectively, tells me an entire sub-strata of the market --who follow and utilize these targets-- may be turning more constructive on HOLX as well.

Second, options-generated data gives us valuable pieces of evidence on sentiment. Unlike analyst targets, those playing options on HOLX have actual money at risk. Options-generated data, therefore, shows us tangible positioning around HOLX to gauge where the capital is being placed. For contracts expiring in July, investors are betting on a further move to $90 with calls showing heavy open interest at this strike on the ladder. Puts are stacked at $80, in line with the current market value.

Extending the term structure out to August, we've got heavy volume and open interest at the $95 mark, telling me investors are positioned for HOLX to drive forward to this point. With the term structure to September, investors are looking as far to $115, with puts stacked at $85 for this time. The fact we've got the bulk of open interest and trading volume on ascending price scale the further we go out in the term structure is tremendously bullish in my view. Investors --with their collectively unique insights and analytics-- believe HOLX will push above the $100 mark to $115 by September. I am inclined to the same view, albeit without the time constraints.

Finally, it's useful to identify where HOLX trades compared to certain averages over time. Moving averages (i.e., 10, 50, 100 and 200-day moving averages) signify key psychological levels across a yearlong period. HOLX trades above its 200DMA, but is a point or two below the 10-100-day averages. But I'm not concerned by this, not one bit. For starters, HOLX is trading above where it was "on average" ~1 year ago (it's above the 200-day). Finally, across basically all time frames (bar the last week) HOLX is well in the green, clear indication of the long-term momentum. With the fundamental and sentimental backing, my opinion is these trends can continue moving forward.

Figure 2.

3. Market-generated data

Additional supportive evidence for the buy thesis is observed in the following series of charts, that show market-generated data on the company. For reference, Figure 3, Figure 4 and Figure 5 will be known as (3), (4), and (5) respectively.

Turning to (3), it shows the weekly money flows into/out of HOLX equity stock since March last year. Note, for basically the entirety of FY'23, YTD capital flows have been positive into HOLX. There have been 4 weeks in total comprising outflows. Naturally, buying power is a requisite to see a stock rate higher-- investors must be willing to pay a higher market value based on their future beliefs for the company. Therefore, capital flows into the equity stock of HOLX is conducive to see it rating higher moving forward as well. This links back with the positive points on sentiment raised in the earlier section.

Figure 3.

Turning your eyes to the weekly cloud chart in chart (4) below, you are actually looking at a valuable trend indicator. The fact HOLX trades above the cloud means it is in bullish territory, and that we have some room to pullback and still remain on trend. Further, the weekly chart looks out to the coming months. As such, I would be looking to support at the top of the cloud, situated at the c.$81-$82 mark, by September/October, should these longer-term trends remain in situ.

Figure 4.

Finally, to corroborate earlier findings on options positioning and sentiment, I have price targets to $104 on the point and figure studies below. These are fantastic studies as for one they are objective, and two, they remove the short-term volatility within a trend to give a clearer indication on the directional bias. Recall that earlier, investors were positioned in HOLX calls (options) with strike depths up to $105 by August/September. In that vein, the fact we've got upsides to $104 is another point that gets me to the next objective of $105-$115, then on to my long-term target of $173.

Figure 5.

Discussion

In the last HOLX publication back in April, I went to great lengths in describing the economic characteristics of the business and why I believe on investment reasoning it to be a long-term buy. I would also submit, that fundamental and economic factors are only one part of the picture. It's one thing to have exceptionally attractive economics, but it's no good to be the best-kept secret in town at the same time.

Alas, a combination of factors is typically required to attract long-term, sophisticated investment. Factors such as investor sentiment, and market data, to show what actual investors, with money at risk, are doing with the company. Looking at these additional critical facts for HOLX, it would appear that both factors --sentiment, price studies-- are also bullish for the company. Options investors are betting on an ascending run for HOLX, with strikes of $95, $105 then $115 over the coming months. Further, analysts have revised targets upwards, and this is being reflected in money flows, trend analysis, and objective price targets obtained from my point and figure studies. I would therefore be looking to a next target of $105, then $115, then my long-term target of $173 that I assigned in the last report. I have no deviation from this long-term view. If new data arrives, to suggest that target needs revising, it will be done-- but until then, I am bullish on HOLX and reiterate it as a buy.

For further details see: