INFU - InfuSystem: Disappointing 2022 Results Lead To Bargain Prices

2023-04-10 10:23:02 ET

Summary

• INFU has produced impressive growth over the past six quarters, but let down investors during this timeframe because it fell short of its own guidance.
• In short, INFU’s business plans simply took longer to come to fruition than the company expected, so the opportunity for massive growth still exists.
• The company’s new business with GE is now well underway with a clearer roadmap and better predictability.
• INFU’s new partnership with SMTI creates a potentially transformative relationship for both companies, especially with the recent FDA approval of SMTI’s newest product, BIASURGE.
• Recent insider purchases seem to be signaling to investors that management has faith in the business, as well as their current guidance for 2023 and beyond.

I have written extensively on InfuSystem ( INFU ) for Seeking Alpha in the past. After I first began covering the stock, it became a big winner. Recently, well, not so much.

What is ironic about this share price action is that the company is now in a better position than ever. The disconnect between the company’s fundamentals and the share price is simple. To paraphrase the INFU management team: the company has done an excellent job growing the business and setting it up for the future; however, they have done a terrible job setting expectations. In 2022, for example, INFU grew revenue by over 10% (a nice growth rate for their type of business), but investors were disappointed as the company had previously targeted closer to 20% growth for the year. I will discuss below why INFU missed its own guidance, but also why I believe the company is now back on track to hit or exceed their FY23 guidance, with explosive growth opportunities possible.

GE Healthcare Partnership Ramping Up

INFU’s relationship with GE Healthcare presents an enormous opportunity for the company. However, up until this point, the delay in revenue related to this deal has been one of the primary reasons for the stock being punished. Long story short, INFU has not “lost” any revenue from the GE deal; it was merely delayed. These delays were outside of INFU’s control, but they appear to now be on the same page with GE Healthcare, with CEO Richard DiIorio indicating on the 4Q22 call that the company now has much better visibility into the roadmap to ramping up GE fully, which should be completed by EOY23.

Ultimately, this delay will benefit INFU in the long run. Not only did the delay led to a higher annual revenue potential for INFU, but working through the process with GE Healthcare has strengthened INFU’s relationship with the company as a trusted partner. For those who have held the stock through these past 15 months or so, there has definitely been some pain; but I do believe investors will be rewarded in the end.

Wound Care Challenges

The wound care space offers material upside revenue and earnings for INFU. They seemed to get off to a hot start in the wound care market by signing an agreement with Cardinal Health ( CAH ), as I highlighted in a previous article . Unfortunately, CAH ended up leaving the wound care business in 2022, which obviously put some pressure on INFU. Still, INFU ended up finding a new partner in this space.

Yet, to INFU’s surprise, this supplier ended up having a supply chain issue in 4Q22 related to circuit boards in one of its components. This left INFU with the inability to ship devices and book revenue in December on a material number of orders. Thankfully, this issue has now been resolved by the partner and INFU has begun making the planned deliveries in 1Q23 per their 4Q22 call. In addition, INFU identified and onboarded multiple other negative pressure device suppliers to help mitigate any future similar scenarios. So, all in all, it seems that this wound care pressure issue is, like the GE Healthcare delay, in the rear-view mirror.

Still, the greatest potential in the wound care space is via INFU’s new partnership (really, more a joint venture) with Sanara MedTech ( SMTI ).

INFU & SMTI: Possible Transformative Partnership

In early November, INFU and SMTI announced a partnership, which is essentially a joint venture. The partnership is officially named “SI Wound Care, LLC.” According to the press release, the partnership is “focused on delivering a complete wound care solution targeted at improving patient outcomes, lowering the cost of care, and increasing patient and provider satisfaction.” According to INFU CEO DiIorio: “Partnering with Sanara enables us to better serve patients and care providers nationally by offering a complete line of advanced wound care products.”

Based on DiIorio’s guidance on the 4Q22 call, I am not expecting much, if any, revenue from the SMTI partnership until 2024. That said, the market seems to have responded positively to last week’s news that SMTI’s new BIASURGE product was approved by the FDA. As you can see, INFU’s stock rallied this past week as a result.

I believe this rally is justified because, as SMTI’s CEO noted with respect to BIASURGE’s FDA approval: “We believe BIASURGE’s biocompatibility, efficacy and ability to be left in a wound without a secondary rinse are a unique combination and will be a market differentiator ” (emphasis mine). From what I have gathered in my own research, I share this optimism. I believe the SMTI-INFU relationship has the opportunity to be transformative to both companies. Combining SMTI’s state-of-the-art products with INFU’s first-in-class service should be a homerun. Perhaps most exciting about the SMTI press release regarding FDA approval was this sentence: “The Company expects BIASURGE to be commercially available in late 2023.”

In other words, it appears that unlike the GE-INFU situation, the SMTI-INFU partnership is actually running ahead of schedule, all while the GE-INFU partnership is now ramping up fully. This situation, together with the recent insider purchases, gives me cause for near-term optimism for INFU’s share price.

Insider Purchases

I often find myself defending small-cap executives when shareholders are pleading for them to buy stock in the open market. First of all, these executives have not only their normal income, but also the vast majority of their net worth, already tied up in the company. It is prudent for them to be at least somewhat diversified. Second, while most of these executives are obviously highly compensated compared to the average American, most of them have a lower liquid net worth than investors imagine (because so much of their net worth is tied up in the company’s stock).

For this reason, I rarely push for insiders buying on the open market. While it is obviously appreciated when they do, I almost never have an expectation they should. With that in mind, I was extremely impressed when INFU’s entire executive team purchased 3,000 shares each on the open market during their open window following the 4Q22 call. The CEO , CFO , and COO all purchased their 3,000 shares within a week of the earnings call.

To me, combined with their bullish commentary regarding 1Q23 and their expectations for the entire FY23, these insider purchases are a clear signal that the days of missing their own stated guidance are behind them. As noted in previous articles, the company’s core business continues to thrive. Now, the GE relationship is full steam ahead and the SMTI partnership is preparing to blossom with the approval of SMTI’s new highly anticipated BIASURGE product receiving FDA approval.

Russell 2000 Inclusion

Each year in late April or early May, the process of reconstituting the Russell 2000 Index begins. For those unfamiliar with this process, let me explain it in some more detail and highlight why it might be relevant to INFU this year.

The Russell 3000 ( IWV ) is an index of the 3,000 largest publicly traded US companies based upon market capitalization. The Russell 2000 ( IWM ) is the smallest 2,000 stocks (based on market capitalization) within the IWV. The Russell 2000 is widely viewed as a benchmark for small-cap US stocks. Many funds-including some funds within 401k plans-will track the IWM. This means that these funds are "forced" to buy stocks that are added to this index each year (and sell those that are dropped from the index).

Again, the IWM reconstitutes itself each year through a process beginning in late April/early May. This year that process begins on Friday, April 28, on what is referred to as " Rank Day .” Rank Day is the date Russell uses to determine the 3,000 largest publicly traded US companies, which then allows them to simultaneously determine the 2,000 smallest among those 3,000 largest. Most of the 2,000 companies that are included in the IWM will be the same as last year. However, some that were in the index last Rank Day will be too low to be included this year (and so will be dropped from the index), while others that were not large enough last year will now be included (and so will be added to the index). There is an entire sub-industry of investors who make arbitrage investments based upon this reconstitution each year. In speaking with some of them, I believe that if Thursday, April 6, 2023, was "Rank Day," the market cap needed to be in the index would be somewhere around $165M - $175M (this is much lower than last year's market cap requirement because the IWM has suffered overall, but the smaller companies towards the bottom of the index's rankings have fallen even more).

Why is this important to discuss now with INFU? Well, INFU closed on April 6 at a $181M market cap, meaning they are likely to be added (if they perform at or above IWM between now and April 28) to the Russell 2000 this year. That is important because being added to the index leads to "forced" buying. As noted, a sub-industry within the investment community makes arbitrage investments every year on scenarios just like this. Specifically, INFU is a fairly thinly traded name. If the company makes the cut-off to be added to the IWM this year, various funds will be required to purchase shares between April 28 and the official IWM reconstitution date of June 23. This buying would be an enormous tailwind to INFU investors as the buying demand from April 28 - June 23 will be unusually high and may help push the share price closer to fair value sooner than rather than later.

Risks

Clearly, the biggest risk for INFU is that management has once again overstated their short-term growth potential. While the company will almost certainly grow in 2023, it is possible that growth will again lag guidance, which could be disastrous for the share price. I believe that the combination of the GE partnership actually ramping and the insider purchases make this scenario quite unlikely. Still, in the minds of many investors, INFU management needs to regain credibility on its guidance.

Another risk with INFU is that the SMTI partnership will not go as planned. Again, this partnership is different than INFU’s other partnerships inasmuch as it is more like a joint venture. While early signs point to that relationship going well, it is always possible that once the bulk of the work has to be done—now that SMTI’s new product is FDA-approved—there could be some conflicts or difficulties with the relationship that could harm the company.

Valuation

The typical valuation metric for companies in INFU’s space is enterprise value (EV) over adjusted EBITDA (AEBITDA). I will, therefore, use this metric as my basis for valuation. Typically, companies like INFU trade for at least 8x EV/AEBITDA if they are a stable business with minimal growth. For growing companies in this space, most especially those with organic growth like INFU, we can use 12x EV/AEBITDA to obtain a reasonable valuation. I would note that, in the past, when INFU was a reliable “cash cow,” constantly beating and raising and increasing cash flows—something I expect to see again in 2023 and beyond—they traded for well above this 12x EV/AEBITDA multiple. All that to say that I believe the 12x EV/EBITDA I will be using is a fair and reasonable metric for INFU at this time.

I currently estimate INFU will earn at least $120M in revenue in FY23 based on the guidance on the 4Q22 call. Further, based on their guidance, I would expect 20% AEBITDA margins. Now, to be fair, I think both of these—revenue and margins—are a conservative, base-case scenario. I think it is quite feasible INFU earns more like $125-$130M in revenue and gets back to 21-22% AEBITA margins.

Based on the more conservative assumptions, I show INFU producing $24M in AEBITDA in FY23. After deducting net debt on the 12x multiple, I have INFU valued at a $250M market cap, or $11.60/share. That price represents a 33% return on a company I believe to be a safe investment. By that, I mean it seems nearly impossible that INFU would earn less than they did in FY22, and the company is predominantly recession proof given the nature of their business (INFU was a homerun off the Covid-19 March 2020 lows for this very reason).

Looking a little further ahead, I believe it is entirely possible that in three to five years INFU could reach $250M in revenue and nearly $60M in AEBITDA. At that rate, I would expect a market cap of around $650M and a share price around $30.25/share, representing a 250% return from current prices.

Conclusion

INFU clearly disappointed investors over the past 18 months by missing their own stated guidance. Regardless, the company has still grown at a nice rate and has multiple opportunities for more significant growth near-term. With the GE Healthcare partnership ramping up currently, and with the SMTI partnership expected to produce meaningful results no later than 1Q24, I expect INFU to return to their previous standard of being a “beat and raise” company. Insiders seem to share my enthusiasm since they have recently purchased shares on the open market. Finally, with the recent rise in share price, which seems to be correlated with the FDA approval of partner SMTI’s new BIASURGE product, INFU is back in play to be added to the Russell 2000 index, which could provide a meaningful tailwind for the share price.

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