DXCM - Up 60% Why I Believe DexCom Is One Of The Best Healthcare Stocks Money Can Buy

2023-12-11 13:52:21 ET

Summary

• DexCom is expected to remain an outperformer in the healthcare sector in 2024, driven by M&A activity and the growth of GLP-1 weight loss drugs.
• The company's continuous glucose monitoring ("CGM") solutions are complementary to GLP-1 therapies and may even increase demand for DexCom's products.
• DexCom's G7 glucose monitor positions the company at the forefront of the CGM market, and its focus on reimbursement and international market expansion contributes to its success.

Introduction

While I have "always" covered healthcare companies, this year, I have stepped up my game and expanded my coverage.

The beauty of health care isn't just that most companies provide fantastic services and products that improve the lives of millions (or billions?) of people. It also helps that demand is mostly anti-cyclical, and growth drivers tend to be secular.

When finding the right players and depending on individual goals and strategies, investors can tremendously improve their portfolios.

One of the companies I started covering this year is DexCom, Inc. ( DXCM ) , the medical devices giant from San Diego, California.

My first article was written on September 12, when I wrote that the stock is up to 40% undervalued.

What followed was a decline, as investors feared that weight-loss drugs would massively reduce the addressable market of the company. It also didn't help that the market, in general, was struggling a bit.

Hence, on October 27, I doubled down, writing an article titled Investors Take Note: DexCom Is Back! Since then, the stock is up more than 30%.

As we look into 2024 (and beyond), I expect DexCom to remain an outperformer. In this article, I'll update my call, using new developments, the company's comments during the recent annual Piper Sandler Healthcare Conference, and more.

So, let's get to it!

Both GLP-1s And Obesity Are Company Tailwinds

On November 19, Seeking Alpha published a very interesting news story, which covered a survey that found that M&A and GLP-1s (weight loss drugs) are expected to dominate healthcare themes in 2024.

According to the report (emphasis added):

According to a recent survey conducted by Jefferies, a significant number of healthcare executives expect the healthcare sector to make a comeback in 2024 , backed by M&A activity and the GLP-1 class of weight loss drugs, as COVID-19 takes a back seat.

In conjunction with its London Healthcare Conference, Jefferies said that a rising proportion of healthcare executives continue to expect a rebound in M&A in 2024 after two years of muted activity .

In 2022, the number and average size of global healthcare M&A fell more than 30% and around 15% , respectively, as companies took a wait-and-see approach amid market uncertainty, according to U.S. consultancy firm Bain & Company. That trend continued this year, with global M&A value falling 44% in the first five months alone .

Although the M&A story does not necessarily apply to DXCM, I have discussed the impact of higher rates a lot in 2023, which I expect to be a major driver of M&A weakness.

After all, there is a huge difference between funding a massive M&A deal at 3% or 7% rates - to give you a very basic example.

At this point, I have to say that I disagree with the GLP-1 expectations. While GLP-1s sure were a large factor in 2023, I think it will quickly mute, just like the positive impact that COVID-19 had on certain stocks.

Over the past three years, Eli Lilly and Company ( LLY ) and Novo Nordisk A/S ( NVO ), two leaders in the GLP-1 field, have returned roughly 280% and 175%, respectively. DexCom has returned 40% during this period.

I'm likely to go in the other direction.

I believe companies that suffered from the GLP-1 trend will be the winners going forward.

See, the news of breakthrough GLP-1 developments did a number on a wide range of healthcare companies.

Why?

Because obesity is a major driver of a wide range of health risks.

According to a scientific article from Kyrou et al. (2018),

[...] it is now well-established that obesity (depending on the degree, duration, and distribution of the excess weight/adipose tissue) can progressively cause and/or exacerbate a wide spectrum of co-morbidities, including type 2 diabetes mellitus, hypertension, dyslipidemia, cardiovascular disease, non-alcoholic fatty liver disease, reproductive dysfunction, respiratory abnormalities, psychiatric conditions, and even increase the risk for certain types of cancer.

In other words, if GLP-1 drugs were to reduce obesity, it would impact the expected growth trajectory of countless companies in other areas.

With that said, don't get me wrong. I'm not against GLP-1s. I believe they are fantastic. Also, although it needs to be seen what the side effects are, I still believe that many obese people may benefit from these drugs tremendously.

I just think that this trend is a bit overblown, as DexCom remains in a good spot despite these drugs.

That isn't just a theory but an actual trend the company is witnessing. This is what I wrote in my most recent article (emphasis added):

Additionally, and in light of GLP-1s, it seems that my expectations have been confirmed. Weight loss drugs do not necessarily compete with DexCom. They may even increase demand for DexCom's products !

According to the company, it is seeing increased interest in the integration of continuous glucose monitoring with new drug therapies .

Claims data indicates that CGM usage grows faster among patients on GLP-1 therapy , reinforcing the complementary nature of DexCom CGM across all therapy regimes in diabetes care, which should take away a lot of overblown fears that DXCM is running into trouble due to GLP-1s.

This brings me to the next part of this article.

So Much Secular Growth & Business Success

A huge part of DexCom's success is its G7, its flagship glucose monitor.

In an increasingly competitive industry, the G7 is a pivotal advancement in continuous glucose monitoring, aiming to enhance user experience, accessibility, and overall effectiveness in diabetes management.

The smaller profile contributes to improved wearability and minimizes the impact on daily activities.

Meanwhile, the reusable transmitter and simplified insertion process contribute to a seamless experience, particularly for those new to CGM technology.

During the aforementioned Jefferies healthcare conference at the end of November, the company said that the G7 positions DexCom at the forefront of the CGM market, offering a competitive edge through its innovative features.

As a result, DexCom is well-positioned to attract both existing CGM users and individuals considering CGM for the first time.

Even better, as the healthcare landscape evolves, DexCom should continue to explore opportunities for seamless integration of the G7 with digital health ecosystems.

Collaboration with health apps, electronic health records, and other platforms can enhance overall patient care and support.

Furthermore, DexCom has historically prioritized reimbursement as a core strategy, aligning with its belief that where there is reimbursement, the company will win.

The focus on making G7 a reimbursed product has contributed to the company's market share gains and underscores its commitment to accessibility.

On top of that, the company noted that commercial coverage for G7 came in faster than initially expected, contributing to the robust Q3 performance.

This acceleration in commercial coverage indicates effective market outreach and acceptance, further supporting DexCom's market penetration goals.

The company is also gaining momentum in new markets, like France and Japan, which is part of its plan to gain a bigger international market share.

It is also looking into a more aggressive expansion in the Nordics, Germany, and the United Kingdom.

Even with regard to competition, DexCom remains upbeat. Bear in mind that this is a competitive market with major players like Medtronic plc ( MDT ) and Abbott Laboratories ( ABT ), both of which are mega-corporations in healthcare capable of spending millions on R&D in specific areas.

During the Jefferies conference, DXCM expressed confidence in maintaining leadership through continuous innovation, highlighting its million years of connected experience compared to competitors.

Although I cannot make the case that competition risks are easing, I agree with DXCM that it has an edge in its industry. After spending so much time researching the company this year and its peers, I believe that DXCM has an edge in this specific area, which it will likely keep for the foreseeable future.

We also need to be aware that DXCM is almost a pure-play company. Its peers are not.

And last but not least, I already mentioned it, but GLP-1s are NOT a headwind for DexCom. The company's CGM solutions are a big part of the GLP-1 therapy for obese patients.

DexCom sees these treatments as complementary rather than mutually exclusive. The company views lifestyle change as an essential element in diabetes prevention and management, and CGM is positioned as an integral part of facilitating this lifestyle change.

Even better, data proves that GLP-1 therapies become more powerful when combined with CGM.

Hence, I not only believe that DXCM is a good trade among companies that (wrongfully) suffered from the GLP-1 hype but also a great stock to benefit from GLP-1 demand.

So, what about the valuation?

Valuation

This is where it gets tricky.

Using the data in the chart below (based on what we discussed in this article):

• DexCom is expected to grow EPS by 66% this year, followed by 17% growth next year and 26% growth in the year after that.
• All of these numbers are much higher than six months ago, as the earnings adjustments at the bottom of the overview below show. This shows that fears have quickly faded, allowing analysts to become more upbeat.
• The company is currently trading at a blended P/E ratio of 83x.
• Over the past five years, the normalized valuation multiple was 150x. Needless to say, I am not using that number going forward, as it's too high for DXCM's growth profile.
• Nonetheless, even a 75x multiple would pave the road for >16% average annual returns through 2025.
• Since 2003, DXCM shares have returned 23% per year.

While DXCM remains subject to market and competition risks, I believe that this company is in a great spot to return more than 14% per year in the foreseeable future.

Takeaway

In my expanded coverage of healthcare companies, DexCom stands out as a resilient performer amidst industry shifts.

Contrary to concerns about GLP-1 trends affecting the company, DexCom's continuous glucose monitoring remains integral to emerging therapies. The G7, a pivotal advancement in glucose monitoring, positions DexCom at the forefront of the CGM market.

With a focus on reimbursement, international market expansion, and confident competition strategies, DexCom navigates challenges better than most may have expected.

While valuation poses a challenge, with a blended P/E ratio of 83x, the company's growth trajectory suggests the potential for elevated double-digit annual returns through 2025.

Despite market and competition risks, DexCom appears poised for sustained success.

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