UTMD - Utah Medical Products: Earnings Power Asset Factors Warrant Further Re-Rating

2023-07-14 17:56:12 ET

Summary

• Utah Medical Products comes with high returns on capital and projected earnings growth into FY'25.
• The company has compounded earnings at a rate of 2.8x that of revenue since 2021.
• Net-net, reiterate buy, eyeing a long-term price target of $223 per share.

Investment briefing

In my April publication on Utah Medical Products, Inc. ( UTMD ), I outlined the bullish case for the company as a long-term investment. In that deep dive, we covered the company's earnings power and asset factors, demonstrating its propensity as a long-term compounder.

As a reminder, the following points feed into the UTMD investment debate:

1. Persistent return on capital commitments of 30–40% with CapEx maintained to 1–2% of total sales. Thus, capital intensity is low, returns on capital are high.
2. It returns capital to shareholders by way of dividends and ongoing buybacks.
3. Internal forecasts implying earnings growth into FY'25 on the back of capital productivity and operating efficiencies.
4. Insiders own ~6.5% of outstanding shares, with management committed to returning capital to shareholders over time.

In this publication, I'll cover the additional tenets forming the thesis, paying close attention to the company's earnings leverage and returns on investor equity. Findings show the company has compounded earnings at a rate of 2.8x that of revenue growth since 2021, with similar trends in gross profitability. Based on the current data and projections going forward, there is all reason to expect these favourable trends to continue, in my view.

Net-net, I am reiterating UTMD as a buy, retaining the $223 upside target portrayed in the last publication.

Figure 1.

Additional critical facts to UTMD investment

Other than the prominent features outlined in my last UTMD deep dive, there are additional critical factors to talk about here today. Starting with the company's latest numbers , posted back in May, you'll note that Q1 FY'23 sales were up 160bps YoY to $12.52Bn. Of this, domestic revenues came to $7.18Bn, down from $7.98Bn the previous year, whereas international sales ("OUS") balanced the scale, up 23% YoY to $5.34Bn. It pulled this to $4.4Bn in operating income and $1.60 in earnings, up 20% YoY.

Table 1. UTMD Q1 top-line disaggregation

1. Earnings leverage

This segues nicely into one of the central points I wanted to discuss here today— that UTMD comes to us with tremendous earnings leverage as well. This is exemplified in Table 2 below:

• Here, the company's first-quarter revenue, gross profit and earnings are listed over the years shown. Over the past 2-years (Q1 2021–2023), UTMD grew revenues by a total of 14%, from $10.96Bn to $12.52Bn.
• At the same time, it grew gross profit by 21%, and, more importantly, pushed earnings 40% higher over the same time.
• This shows the 14% 2-year growth in turnover correlated to a 40% growth in earnings; otherwise, 2.85x earnings leverage. Said another way, every $1 growth in revenue produced 2.85 turns in net income per share— tremendous leverage, as mentioned earlier.
• This links explicitly to the points I raised last time, in that UTMD can produce high returns on its capital commitments (invested capital) without an enormous growth in sales. Here, it shows the firm also produces attractive growth from a small uptick in revenues, adding to the reiterated buy thesis.

Table 2. UTMD long-term sales, gross + earnings

• note: Q1 is shown for each period

2. Capital productivity

I had discussed the firm's returns on existing and incremental capital at lengths in the last publication, but you need to understand additional factors for UTMD when it comes to capital productivity, in my opinion. Why?

One, it pulled the $12.25Bn in Q1 revenue to $310mm in gross, a YoY increase of 4.1%. As previously mentioned, growth in gross profit outpaced revenues, and this is traced back to 2 favorable differences:

• The firm was able to absorb manufacturing overhead at its Ireland facility as production ramped up, combined with a reduction in the company's healthcare costs for U.S. employees [UTMD has a self-funded healthcare plan for its employees].
• Selective adjustments to product pricing based on specific vendor costs.

Subsequently, there's a probability UTMD may experience ~25-50bps gross margin decompression into the remainder of FY'23 based on these changes in my view.

Two, the company routinely generates $0.25–$0.28 for every $1 in operating assets [using TTM figures]. Whilst this isn't the highest absolute number, it is still important for a couple of reasons. For starters, the company has grown total assets from $107mm in Q3 2020 to $127.8mm last quarter. Gross capital productivity (measured by the rolling TTM gross profit scaled by total assets each quarter) increased from 22.1% to c.25% in the same time. This indicates an ~300bps gain in gross profitability. Further, the gross productivity correlates to the attractive earnings leverage described earlier.

Figure 2.

Three, the benefits to shareholders on these productivity gains are equally as relishing in my view. You'll note below, the rolling TTM return on equity posted over the testing period. Here, ROE is equated as the net operating profit after tax ("NOPAT") as a function of net asset value.

You will observe that, just like in Figure 2, the firm has grown its equity at similar pace to total assets, by a total of 20% over this time. From this, it's added another 130bps in profitability, such that in Q1 FY'23, equity holders were rewarded with an 18.5% return on their equity. Note, this is also ahead of the 14% growth in sales– further bullish confirmation in my view. This is exemplified by the fact inventory turnover comes at 2x, with accounts receivable paid within 27 days over the last quarter. Hence, it converts inventory to income at quite the pace.

Figure 3.

Valuation and conclusion

In the last publication, I laid out the valuation case for UTMD to trade to $223 per share based on a multitude of inputs. With the points on earnings power and asset factors discussed here, I am more than comfortable retaining this objective moving forward.

You'll note below the market has priced it at 20x trailing earnings, and 9.5x EBITDA. Comparatively, this measures up well to peers, and you'd be asked to pay 15x cash flows to buy UTMD today. To this point, you're paying 15x for "... stable, predictable long-term cash flow and earnings that continue to grow without discrepancy" , as mentioned last time. This is attractive to my investment cortex. We shouldn't forget the $1.18 in dividends expected for payout over the coming 12 months either. Hence, I am reiterating my valuation of $223 per share, noting the companies standing relative to peers in the process.

Figure 4.

In short, UTMD continues to present with the kind of earnings power and asset factors that make it an investment grade company in my eyes. The earnings leverage and returns on shareholder equity portrayed in this report only add fuel to the UTMD investment fire, and build extensively on the additional economic characteristics I've outlaid previously. I am still looking to $223 as a long-term price target for this name. This appears to be well supported by fundamental, sentimental and valuation data as well, putting more bullish weight to the risk-reward calculus. Net-net, reiterate buy.

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