IRTC - iRhythm: AI Products May Be Better Than Cardiologists And Stock Looks Cheap

2023-04-26 17:22:35 ET

Summary

• iRhythm Technologies, Inc. offers innovative solutions in the field of digital healthcare.
• I believe that investors will likely pay special attention to the fact that iRhythm uses FDA-cleared artificial intelligence. Nature Medicine in 2019 published information about the results.
• iRhythm Technologies has established itself as a leader in the digital healthcare market with its innovative Zio ambulatory cardiac monitoring system.
• Initial efforts to proactively monitor population with Zio XT System are planned for 2023.

Equipped with artificial Intelligence, the products offered by iRhythm Technologies, Inc. ( IRTC ) were mentioned in a study by Nature Medicine for obtaining better results than cardiologists. With this, the company is expecting enhancement of its portfolio, and adding products in adjacent markets like undiagnosed and/or asymptomatic cardiac arrhythmias. In my view, even considering risks from failed market assessment and the billing complexity of Zio services, I believe that the stock is undervalued.

FDA-cleared Artificial Intelligence That May Be Even Better Than Expert Cardiologists

iRhythm Technologies, Inc. offers innovative solutions in the field of digital healthcare with its Zio ambulatory cardiac monitoring technology. Its Zio system, which combines a portable biosensor and cloud-based software, enables clinicians to efficiently and quickly diagnose arrhythmias, which can lead to more timely and effective care for patients.

I believe that investors will likely pay special attention to the fact that iRhythm uses FDA-cleared artificial intelligence. Nature Medicine in 2019 published information about iRhythm.

Our Zio Services utilize advanced FDA-cleared artificial intelligence with the only deep-learned algorithm. As published in Nature Medicine in 2019, Hannun et al. used data from the Zio XT Service to develop a deep-neural network capable of diagnosing arrhythmias at a high diagnostic performance similar to that of expert cardiologists. The deep-neural network model met or exceeded the performance of cardiologists for 12 types of arrhythmia classes and recapitulated the misclassifications made by cardiologists. Source: 10-k

With approximately more than five million patients using its services and more than one billion hours of heartbeat data collected, the company has demonstrated its leadership in the market. Furthermore, with presence in several major cities in the United States, in my view, iRhythm Technologies is positioned as a reliable and strong company in the healthcare industry.

The company focuses on direct marketing of its Zio Services in the United States, and is aimed at healthcare professionals who diagnose and manage the care of patients with arrhythmias. The company has been successful in focusing on integrated delivery networks, and is exploring opportunities in the UK, Japan, Switzerland, the Netherlands, and Spain. Besides, management sees opportunities in monitoring asymptomatic patients with atrial fibrillation.

I also recently changed my long term expectations about the company because of its recent guidance for 2023 and the expectations of other analysts. The numbers expected by iRhythm are quite impressive. Management believes that Adjusted EBITDA margin would stand at close to 0.5% or -0.5%, with gross margin close to 69%-70% and net revenue of $475-$485 million.

Competition Is Driven By Innovation, And Large Conglomerates Are Involved

The remote cardiac monitoring market is highly competitive, and is constantly changing due to technological advances and market activities of industry participants. iRhythm Technologies competes with companies such as BioTelemetry, Preventice Solutions, and Bardy Diagnostics to offer remote cardiac monitoring technology and diagnostic services.

In addition, it competes with companies that sell traditional 24 to 48-hour monitoring, such as GE Healthcare (GE), Philips Healthcare (PHG), and Spacelabs Healthcare. With increased acquisition and consolidation activity in the industry, iRhythm Technologies' competitors have greater financial, manufacturing, and marketing resources along with an established customer base and well-established brands. Also, future competition could come from big tech companies focused on general health and wellness.

Expectations Include Sales Growth And FCF Generation In The Next Three Years

I believe that having a careful look at the expectations from other investment analysts will help the investors who may not believe in the future of the products. Market expectations include 2025 net sales of $680 million, net sales growth close to 19%, 2025 EBITDA of $68.5 million, an EBITDA margin of 10%, and 2025 net income close to -$38.1 million.

With that about the income statement, the most interesting, in my view, is the cash flow statement. Analysts expect FCF to grow from negative territory in 2022 to close to $175 million in 2023 and $130 million in 2025. The expected increase in FCF is what made me design a DCF model for the company.

Assets: Significant Amount Of Liquidity And Stable Position

As of December 31, 2022, iRhythm reported cash and cash equivalents of $78 million, with short-term investments of $134 million and accounts receivable of $49 million. Also, with inventory worth $15 million and prepaid expenses and other current assets of $10 million, total current assets were equal to $288 million. The total amount of current assets is around 2.9x the total amount of current liabilities, so I do not believe that we have a liquidity issue here.

Property and equipment stood at $75 million, with operating lease right-of-use assets close to $60 million and total assets of $448 million. The asset/liability ratio is equal to more than 2x, so I believe that the balance sheet has a stable position.

A Small Amount Of Liabilities

iRhythm reports a small amount of debt and few liabilities. In my view, a significant amount of cash in hand means management likely does not have to talk to financial institutions or providers to finance the operations. It is, in my view, quite ideal.

iRhythm reported accounts payable worth $7 million, accrued liabilities of $65 million, and deferred revenue of $3 million. Total current liabilities are equal to $89 million. Finally, long term debt stands at $34 million, with total liabilities of $208 million.

My Assumptions Include More Market Awareness, Market Penetration In The United States, And Successful Expansion In Europe In 2023

I believe that further expansion and market penetration by targeting the large existing ambulatory cardiac monitoring market in the United States will bring revenue growth. Sufficient marketing efforts as well as enhancement of the current portfolio of products will likely bring revenue growth. The company believes that the current market penetration is only close to 25%.

Zio XT System, which provides continuous long-term ECG monitoring, is appropriate for the majority of patients that require ambulatory cardiac monitoring while Zio AT System, which includes near real-time monitoring, is appropriate for more acute patients that require timely notification. We estimate our current market penetration in the United States to be approximately 25%. Source: 10-k

I also believe that sufficient information about why devices like that of iRhythm are necessary could also make more doctors and clients interested. I believe that management will do good by noting the report issued by The American Journal of Cardiology. In this regard, management made the following comments.

We estimate that 14 million patients in the United States visit a primary care physician annually with palpitations due to suspected cardiac disease. Source: 10-k

A retrospective study by Turakhia et al, published in The American Journal of Cardiology in August 2013, analyzed data from 26,751 patients using the Zio XT System for the first time between January 1, 2011, and December 31, 2011. The study results showed that among the 16,142 patients with detected, clinically relevant arrhythmias, over 50% of the first-diagnosed symptomatic arrhythmias occurred after 48 hours of monitoring, suggesting that these arrhythmias could have been missed by traditional Holter monitoring during the typical maximum prescribed monitoring time. This data suggests that detection of infrequent arrhythmias requires longer monitoring times and ECG signal of consistent quality. Source: 10-k

The company is also seeking international expansion opportunities in European countries, Japan, and the UK. In particular, in 2023, the company expects to develop new initiatives in Europe, which may bring news to the market, and accelerate the demand for the stock.

We are initiating market development and market access initiatives in multiple European countries in 2023 and pursuing regulatory clearance in Japan. Source: 10-k

I also believe that adjacent markets like undiagnosed and/or asymptomatic cardiac arrhythmias could increase the target market. As a result, potential revenue growth could accelerate, which may bring more interest from market participants. In this regard, new efforts are expected for 2023, so I believe that paying attention to the stock will likely help.

We are pursuing commercialization opportunities for our Know Your Rhythm by Zio program that is focused on patients at risk for undiagnosed arrhythmias. With at least 12 million individuals in the United States estimated to be at risk for undiagnosed and/or asymptomatic cardiac arrhythmias, we believe this is a significant market opportunity. Initial efforts to proactively monitor this population with Zio XT System, including end-to-end care pathway pilots, are planned for 2023. Source: 10-k

My DCF Model Implied A Valuation Of $158 Per Share

My cash flow model includes gradual increases in FCF driven by increases in net income accompanied by increases in depreciation, increases in accounts payable, and increases in deferred revenue. I also believe that capital expenditures would likely increase as will the CFO. My numbers are pretty much aligned with previous figures for accounts receivable, accounts payable, and inventories. I am really not thinking out of the box because I want realistic figures.

The net income growth, CFO growth, and FCF growth that I assumed are aligned with the expected growth of the global ambulatory cardiac monitoring devices market, which appears to be close to 10%. My numbers are a bit more significant than that of the market because iRhythm is a new entrant. FCF growth in 2033 is expected to be close to 12%, and 2033 net income growth would stand at 16%.

The global ambulatory cardiac monitoring devices market size was valued at USD 5.77 billion in 2022 and is expected to expand at a compound annual growth rate of 10.4% over the forecast period from 2023 to 2030. Source: Ambulatory Cardiac Monitoring Devices Market Report

The assumptions I made in my DCF model included deleting certain items from the cash flow statement because they do not seem like activities related to the business model. Reimbursement of tenant improvements was assumed to be zero from 2023 to 2033. I also assumed that impairment changes and changes due to other assets would be close to zero.

My numbers are a bit more conservative than what other investment analysts are expecting. I included 2023 net loss of -$94 million, depreciation and amortization close to $16 million, and stock-based compensation of $67 million. Besides, changes in accounts receivable of -$76 million and changes in inventory of -$8 million resulted in a net cash used in operating activities of -$1 million. If we also assume purchases of property and equipment of -$41 million, 2023 FCF would be close to -$41 million.

My figures for 2033 include net income of $211 million, depreciation and amortization close to $49 million, and stock-based compensation close to $147 million. Also, with amortization of -$6 million, amortization of operating leases of $7 million, changes in accounts receivable of -$194 million, and changes in inventory of $26 million, I obtained net cash used in operating activities of $484 million. If we also include capex of -$120 million, the FCF would be close to $364 million.

If we sum future FCF, and use a WACC of 7.4%, the enterprise value would stand at $4.782 billion. Besides, if we sum cash of $78 million, and subtract noncurrent debt of $34 million, the company value would stand at $4.826 billion. Finally, the fair price would stand at close to $158 per share.

Risks

The company is exposed to various risks and uncertainties, including those related to regulation and reimbursement by Medicare and other commercial payers. If doctors, regulators, and insurance companies decide that the devices are too expensive or not necessary, I believe that revenue expectations would decline. In particular, we do not know yet how European or Japanese hospitals and the social security systems will feel about the innovations offered by iRhythm.

The ability to innovate and expand internationally as well as the need to attract and retain senior management and key personnel are also significant risks. In my view, iRhythm will need a significant amount of cash for issuing new products in existing or related markets. If investors decide not to give further cash to iRhythm, I believe that FCF expectations would most likely decline.

It is also worth noting that expectations about future FCF growth from management, investment advisors, or even my DCF model could be wrong. If the target market is overestimated, I believe that future FCF would be lower than expected, which would imply a lower implied stock price.

My Conclusion

iRhythm Technologies has established itself as a leader in the digital healthcare market with its innovative Zio ambulatory cardiac monitoring system. With a strong presence in the United States, I believe that the company has a stable customer base and a trusted brand name in the healthcare industry. Competition in the market for ambulatory cardiac monitoring solutions and the billing complexity of Zio services remain significant. Besides, risks from overestimation of the target market could imply lower FCF than initially expected. With that, I believe that the stock is undervalued.

For further details see: