INMD - The InMode Rollercoaster: Navigating The Revenue Adjustment

2023-10-13 10:40:15 ET

Summary

• InMode shares experienced a significant drop of 20% in one trading day, but the decline is seen as excessively harsh.
• InMode's unique product line bridges the gap between surgical procedures and standard laser treatments, making it stand out in the market.
• Despite a downward revision of FY 2023 revenues, INMD stock remains undervalued and presents a buying opportunity.

InMode Overview:

After closely examining the InMode Ltd. ( INMD ) business model and financials last July, I recommended an investment in the company, believing it to be a solid BUY. On October 12th, InMode's shares plunged to a new 52-week low, seeing a dramatic drop of 20% in just one trading day. Understandably, this development called for an update to my initial projections, leading to this fresh analysis.

To grasp the essence of this update, I'd suggest revisiting my initial assessment. There, you'll find a comprehensive breakdown of InMode's business model, its product line, the company's competitive standing, and what sets it apart from other medical laser manufacturers. The heart of that piece was a DCF (Discounted Cash Flow) model crafted from the data available at the time. This new analysis hinges on the DCF as well, but updated with the fresh data we now have at our disposal.

In light of the new calculations, I believe the recent dramatic decline in InMode's share price, particularly the slump on October 12th, is excessively harsh. While there have been some unfavorable developments, in my opinion, they are nowhere near dire enough to justify such a significant drop. On the contrary, I now see InMode's stocks as a STRONG BUY, making the current dip a golden opportunity for investors.

A Recap of the Previous Analysis

InMode is an Israeli firm specializing in laser machinery for cosmetic medicine. The demand for laser treatments has skyrocketed in recent years. Compared to plastic surgery, laser treatments are quicker to administer, have shorter recovery times, don't require anesthesia, leave no scars, and are more affordable. However, traditional lasers typically yield results markedly inferior to plastic surgery, and not every patient reacts positively to the treatments.

For the over-40 demographic in particular, traditional lasers often yield hardly noticeable effects. This puts patients in a dilemma: Should they endure a lengthy, painful, and costly surgical procedure for superior results, or opt for a cheaper and simpler laser treatment, knowing the outcomes might be underwhelming?

InMode has risen to the challenge, creating a product line that bridges this gap. Their "minimally invasive" lasers stand at the intersection between surgical procedures and standard laser treatments. While their recovery time is slightly longer than that of traditional lasers, it's considerably shorter than surgical recovery times. Plus, there are no scars, the treatment duration is akin to standard lasers, and the results? Somewhere in between traditional laser treatments and surgery.

This innovative approach has carved a unique niche for InMode in the market, distinctly setting their offerings apart from typical cosmetic medical laser providers. Their devices are assembled by an OEM, which is paid a fixed sum per machine. These devices are then either sold or leased to cosmetic doctors and plastic surgeons. The company's cost structure ensures predictable margins, while InMode's level of innovation and technology ensures these margins remain lucrative.

Key Updates to Consider

Since my initial assessment, two significant variables have shifted. First, there were the unfortunate recent events in Israel, which directly impact any enterprise based in the country. Thankfully, InMode swiftly released a statement reassuring the safety of its employees and confirming no disruptions or delays in their production line due to the current events.

Naturally, these events have shaken investor confidence. Over the past five trading days, the shekel has depreciated by 3.45% against the dollar, and despite this currency devaluation, the Tel Aviv 35 index has also shed almost 10% of its value. However, it seems that Israeli forces have now regained full control of their territory, suggesting the gravest threats to InMode are behind them.

The second update comes from a press release that precedes the official quarterly data release, scheduled for November 2nd. The statement indicates that FY 2023 results will fall below expectations, primarily due to a slower-than-anticipated growth rate during the third quarter.

Revised 2023 Revenue Forecasts

In its latest press release, the company informed its investors about a downward revision of its FY 2023 revenues. The highlights were four-fold, which I'll encapsulate below as they appeared in the statement:

Revenue for the third quarter of 2023 to be in the range of $122.8 million to $123.0 million

• Non-GAAP earnings1 per diluted share for the third quarter of 2023 to be in the range of $0.59 to $0.60

• Revenue for the full year of 2023 to be in the range of $500 million to $510 million vs. previous estimates of revenue between $530 million and $540 million

• Non-GAAP gross margin for the third quarter of 2023 in the range of 83% to 85%

Nowhere in the text did InMode reference the prevailing geopolitical climate. From the information provided by the management, this downward revision seems to stem from the slowing economic activity and rising interest rates in its key markets, namely the United States and Europe.

The company points to stricter leasing conditions, a cautious approach by banks, and heightened checks that have bottlenecked loan approval processes. This seems in line with the present scenario, considering that on October 10th, mortgage rates in the US hit a 23-year high.

What's pivotal for me, and for long-term shareholders, is what isn’t mentioned: there's no sudden upsurge in competition, no emergent and significant alternative technologies, and no change in consumer trends. There's no tangible reason to believe that there's any major factor behind this contraction in 2023 growth predictions. I'd also like to highlight that we're looking at a 5% revenue dip, with no corresponding dip in sales margins, yet the stock took a 20% hit in a single trading session.

Reassessing INMD Stock via the DCF Model

My immediate hunch was that the markets were already on edge with any stock related to the ongoing events in Israel, and InMode’s latest press release merely triggered a panic selloff.

Approaching this analytically and methodically, I revisited the numbers to gauge the company's prospects based on the current data.

I chose to model an extremely bearish scenario where InMode's growth rate doesn't bounce back in the coming years, especially as monetary policies inevitably ease up. I simply used this year's projected growth rate, adjusted in light of the revised revenue outlook, and gradually tapered it over 6 years to conclude at a final growth rate of 4%.

Regarding margins and capex, I made no adjustments: margins mentioned in the recent press release are perfectly aligned with previous quarters and the DCF I highlighted in my first analysis. Capex wasn’t addressed in the press release, but we can afford some wiggle room given its historically minimal imprint on InMode’s finances.

DCF Calculation

Here are the pivotal assumptions I leaned on to update the DCF:

• This year’s revenues are pegged precisely midway within the range projected by InMode's recent forecasts.
• Business profitability and margins, as well as capex and the net working capital changes, are deduced from InMode's 5-year historical averages.
• For the WACC calculation, I updated the risk-free rate, referencing 10-year Treasuries.
• The terminal value is calculated using a 14-times multiplier — decidedly conservative — vis-à-vis the final projected fiscal year.
• The risk premium, compared to my previous analysis, was adjusted from 3% to 4%, accounting for heightened geopolitical risks.

Given this backdrop, my WACC calculation used to discount the cash flows stands as follows (Data in $ million, sourced from Seeking Alpha):

Moving on to the projections of the coming years, here is what we have:

By summing all the discounted cash flows from now until 2029, we arrive at a total of $1.628 billion. We then move on to the calculation of the terminal value, remembering that I used a multiplier of 14x compared to the net income of 2029:

We are now ready to put everything together in the calculation of InMode's intrinsic value:

Now, let's relate all of this to the share price and the company's current valuation:

Conclusions and Final Thoughts

Even though I strived to use pessimistic forecasts and a very conservative multiplier for the terminal value, InMode Ltd. stock still appears more undervalued today than it was when I wrote my initial analysis at the end of July.

As often happens, a moment of market uncertainty can turn into a wave of panic. I believe this is precisely what happened in this case, and I am ready to double down on my position to take advantage of it. As long as the product is a winner and the margins are so high, I am more than happy to endure a downturn: if it means buying at current prices, I would even say I am excited.

A 5% drop in forecasted revenues for this year cannot justify a 20% drop in stock value. One doesn't need a detailed DCF to understand that. However, the detailed DCF served to understand that even in the face of a severe and prolonged deterioration in the growth rate over the next few years, InMode would still remain an excellent stock to invest in.

Risks and Factors to Consider

Like all analyses, mine is exposed to the risk of unforeseen events. Specifically, of course, I am currently concerned about what's happening in Israel. However, my opinion is that the Israeli military will in no way allow such attacks to repeat and that the alert level has never been higher. Just as with the 9/11 events in the U.S., I believe that all security measures from now on will be even stronger and will make InMode safer than ever.

Another uncertainty for the coming years concerns the advent of new technologies, even if there is currently no specific contender that threatens InMode's specific market niche. All competitors are significantly smaller, and InMode has well-protected its intellectual property with patents, so I don't see any new competitors emerging in the minimally invasive laser niche.

I believe that the current risks are not enough to change my position on InMode Ltd. stock, and that the current circumstances offer a great opportunity to buy the shares at a discount.

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