RMTI - Returning To Rockwell Medical: Buy At 65% Of Revenue

2023-11-30 01:42:46 ET

Summary

• Rockwell Medical is arguably the strongest player in the hemodialysis market and a top 5 healthcare supplier per Seeking Alpha Quant.
• The Company still addresses a critical medical condition and has a large global market that I don't believe is near fully penetrated.
• There is an operational turnaround strategy being executed that is focused on cost-cutting and industry roll up to improve financials.
• This is a high risk, high reward scenario where risks include further dilution, the artificial kidney coming to market on time or sooner, and operational losses.

Introduction

In returning to Rockwell Medical ( RMTI ), I maintain all aspects of my prior thesis published here . The Company remains a strong player in the hemodialysis market and a well-rated Healthcare Supplies industry leader. The Company is still addressing a critical medical condition for patients suffering from Chronic Kidney Disease and other life-threatening kidney conditions. The total addressable market remains large and characterized by limited life-saving treatment options. There is a long waitlist to receive a donated kidney, making dialysis, the alternative option, a steady healthcare business. Until another substitute, such as the artificial kidney , comes to market, I see value here. We may have this as soon as 2030, which is when the team at U.C. San Francisco is targeting commercialization. Despite this, I argue that The Company does not deserve to be trading at its current multiples.

Operations

Rockwell Medical is a vertically integrated business that manufactures and distributes inputs to dialysis treatment centers. The product line is comprised of various acid and salt concentrates and powders. It manufactures across several states in the U.S., and manufacturing became partially automated in Q3 2023 according to The Company on its recent earnings call.

As a distributor, Rockwell Medical owns a subsidiary, Rockwell Transportation, that delivers to customers spanning across the globe. In the United States, Rockwell Medical has 33% market share, and they recently completed their second acquisition in under a year that added 1,700 new locations to service. The new accounts won through acquisition will challenge Rockwell Transportation as the network of customers grows.

I am bullish on the trend of acquisitions when considering The Company's future asset levels and strategic positioning, ahead of competitors as measured by margin. Margin is a key operational performance indicator, and one way to improve it is by lowering expenditures, particularly large ones that joined entities can share.

Finally, in the healthcare market, a consistent and defect-free product is essential to a company's success, as errors can be a matter of life or death. Controlling both the manufacturing and distribution process, the former now being automated to eliminate human mistakes, The Company stands to achieve a high level of quality control. Many factors critical to success are within their operational control, such as contaminated or defective product and logistical contingencies.

Financials

In the recent Q3 earnings call, the CEO and President Mark Strobeck reported, "During the third quarter of 2023, we generated net sales of $23.8 million, including concentrate product sales of $21.6 million." This annualizes to $95.2 million. Current forecasts for 2024 revenue are just around $98 million. It seems to me like Rockwell Medical is on track to meet expectations or exceed them with a modest acceleration in the current growth rate. Profitability is not so great with net losses on the chart below. However, profitability is in a clear uptrend driven by both downtrends in total expenses and uptrends in revenue.

To view how the two recent acquisitions have strained share prices, I made the next chart. While debt hasn't been much of a problem for shareholders in recent years, it seems that the acquisitions and financial losses are straining shareholders through equity offerings. The price of a stock typically dips when management announces that they are raising capital by selling stock because existing shareholders are diluted by an increased supply of shares. Technically, the price alone shows that a longer term downtrend ceased in early-to-mid 2022. The stock is still in an uptrend between lows in 2022 and 2023 respectively. There is evidence that a reversal may take place, and that it might be characterized by several more upward spikes.

Valuation

Despite a solid trailing YoY revenue growth rate of 17.44%, RMTI only trades at 65% of its revenue. The median healthcare company, which operates at a loss of $315,420 per employee compared to RMTI's loss of just $36,720 per employee, trades at around 3.46X its sales. Net income per employee is a key measure of value, as employees are an expense that should yield more output and not less. Capital expenditure and revenue growth are both positive and significantly better than the sector median. There is little reason for shares to be so heavily discounted in my opinion.

On the other hand, working capital has been depleted, likely from acquisition transactions, and this Quant grade F drags the final grade down because working capital is a key driver of revenue and its growth. Looking at the most recent balance sheet, I find a book value/share of $0.76. Taking the price per share at the time of writing and dividing it by $0.76, I calculate a price/book ratio of 2.5, which is not terribly high compared to a sector median of 2.44. The discount on sales seems to reflect negative EBITDA, dilution from acquisitions, and emerging treatments for Chronic Kidney Disease. I believe these strains on valuation are unsustainable given the revenue and profitability potential The Company has in its operational narrative.

Risks

One measure of the intrinsic value of the company that assumes no future cash flow to the company is the book value/share ratio. This suggests that if considering nothing else but the balance sheet, shares are worth $0.76, or a downside of around 60% from the market price. The path to profitability seems priced in on account of this large downside. I therefore classify this as a high risk, high reward scenario because this stock can, has, and might again make 100%+ advances.

I think the biggest risk to share prices is further dilution. The high rate of dilution pictured above is in my opinion reflective of burning cash in operations and the financial strain that acquisitions have inflicted on Rockwell Medical's balance sheet. The low price/sales ratio combined with the average price/book ratio has not been compelling enough to the market given the massive amounts of dilution. The second-biggest risk is the artificial kidney coming to market as a substitute product. As much as I hope for medical advances to be made, dialysis remains a life-saving treatment option.

Conclusion

Rockwell Medical remains on my watch list, as does every stock I have covered and will cover. I will watch for profitability as the recently announced automation of manufacturing reduces costs, as do synergies. The payoff potential is quite high, I believe. I do not expect The Company to pay a dividend any time soon, but rather to make operational improvements that will profit shareholders by strengthening the balance sheet. If it can complete an industry roll up, then I see no reason why Rockwell Medical can't be a legitimate turn around story well into the three or four digit return range. This piece reflects my honest market outlook on 11/29/2023 as I write and is subject to change, revision, or follow up to be published exclusively on Seeking Alpha .

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