2023-04-20 04:57:42 ET
Summary
- Artivion continues to trade sideways with challenges to growth looking ahead.
- The PROACT Xa overhang looks to be now priced in, but there's additional hurdles still to overcome.
- I believe AORT is overvalued and should trade at 13x forward EBITDA.
Investment Summary
The woes for Artivion, Inc. ( AORT ) may have begun to subside for the time being. Investors look to have fully priced in the detrimental effects of the PROACT Xa trial withdrawal, and shares have curled up 13% this year to date. I had covered this at lengths in my last AORT publication in December last year.
Despite the market's complacency with AORT I do not believe an upgrade to the rating from hold is warranted at this moment. It is my humble opinion that investors were rewarding the company on its potential to knock Warfarin off the table as the standard label for anticoagulants. Further, with comparable names like Integra LifeSciences ( IART ) and LivaNova ( LIVN ) offering earnings yields of ~6% and 5.5% respectively, it is hard to see relative value in AORT stock as risks still remain around its growth route looking ahead. The company could grow-top-line revenues by 5% in FY'23 to ~$330mm in my estimates, yet, operating income could also fall 35% YoY to below $10mm as well, presenting a challenge to the stock re-rating beyond the 22x forward EBITDA it currently trades at. Net-net, I reiterate AORT as a hold with an $11 price target, or 13x forward EBITDA.
Top-line growth not reflected in P&L, cash flow
Looking to firm's growth in FY'22 , total product and service revenues grew 5% YoY to $313mm, underscored by strength in its On-X and aortic stent grafts product lines. Much of the revenue outlook going forward hinges on the firm's ability to get PROACT mitral back on track for approval. Per the Q4 earnings call:
As PROACT Mitral we are maintaining interactive dialogues with the FDA and look forward to a potential approval in the second half of this year. We do not believe that securing this approval is imperative as it relates to our ability to achieve our near and longer term growth revenue growth forecasts. We've not included the potential approval in our outlook for 2023.
AORT began the PROACT Mitral studies more than 10 years ago, with the latest trial data showing it missed the primary endpoint of bleeding in thromboembolic events. Notably, the company is looking to H2 this year for a potential approval for PROACT Mitral, contrasting to an estimated approval in H2 FY'22. The question is, why the delay? Management noted the issues around missing the endpoint and the FDA's potential over-scrutiny on the latest data as leading cause. However, potential approval in H2 could be a meaningful tailwind to attract investment. In the same breath, it is also optimistic about receiving a pre-market approval for its Per-Clot product later this year as well. Currently, it is working on labelling for Per-Clot and purchased ~$2mm in pre-launch inventory for the product in Q4 last year. This could be a tailwind, as it won't recognize any revenue costs tied to Per-Clot if sales are booked post-approval.
Fig. 1 - AORT YoY Segment Performance, FY'21-'22
Looking to the remainder of FY'23 my numbers estimate that AORT could generate ~$330mm in top-line revenues this year on a gross margin of 66%. I would see this margin carrying through into the following years. Management have forecast a range of $331-$343 and I believe AORT will hit the lower end of guidance. Driving these estimates for me, are the continued growth of its core segments, plus the potential contribution the Per-Clot PMA as an upside surprise.
It also sees annualized EBITDA of $75-$80mm in EBITDA by FY'24. I just can't get there on this though. There are multiple challenges to growth AORT must overcome:
- Staffing issues in its Germany footprint clamped top-line growth last year. The firm says this has been resolved, yet there's no indication of this just yet. I believe this could still be a bit iffy looking ahead.
- Further, there are multiple headwinds hospitals are facing throughout the globe in H1 this year. Namely, strikes from key staff segments like nursing and physicians. This cannot be discounted.
- The company is still facing issues with the FDA regarding its PROACT segment. Granted, PROACT aortic missed the endpoints of bleeding and reduction of bleeding. The same occurred with the primary endpoint in PROACT Mitral. Interestingly, the firm grouped bleeding and thromboembolic events as primary endpoints together, which meant PROACT Mitral failed on the primary outcome. The FDA actually wants them to be separate outcome measures. Hence, AORT is going to have a challenging task in convincing the FDA that it should be looking at the data in the same respect. We can expect the PROACT 10A top-line data when AORT presents at a plenary ATS session in Los Angeles in May.
Fig. 2
It is for these reasons that I forecast a period of lumpy operating income and EBITDA growth for the company looking ahead (Figure 3). I've got AORT to hold an 11% EBITDA margin which would equate to just $40mm in FY'24 on my numbers. Hence, the wide dislocation in the company's estimates to my own is another reason why I am not as constructive on re-rating to a buy at this point. A change to the input data from outsized earnings this year could change this viewpoint, for sure.
Fig. 3
Aside from the reasons above, my analysis has alluded to the discrepancies in AORT's revenue booked to the cash it is generating. Here I took the last 12 trailing 12-month periods to Q2 FY'20 on a rolling basis, and compared the amount of cash flow it is generating from operations versus the revenue is booked and the change in its accounts receivable. Key findings:
- Despite an overall uptick in turnover booked, the cash backing these revenues has dwindled to sub-zero on a rolling TTM basis. The trend has been in situ across the entire testing period [Figure 4].
- Further, the degree of cash backing AORT's receivables has also trended south dramatically over this time as well.
- In the same vein, the amount of receivables booked relative to cash collection has been diverging unfavourable since FY'21 at least, whereas previously, it was largely in tandem [Figure 5].
This tells me the quality of AORT's revenues aren't as clean as I'd like them to be to allocate capital to this name. The preference would instead be to observe cash flow at ~40-80% of revenues, cash collection increasing against receivables, and CFFO increasing as a percentage of accounts receivable. Alas, I'd need more compelling data to suggest AORT is worth a nibble at this stage.
Fig. 4
Fig. 5
Valuation and conclusion
The market has still generously priced AORT at 17x forward EBITDA and ~1.9x book value. This is an unjustified premium in my opinion. At 17x this is ~30% above the sector at 13x. Further, without the prospective PROACT-related assets to drive net asset value, 1.9x is far too steep. I'd be far more inclined to see AORT fairly valued at the sector multiple of 13x forward EBITDA. On my FY'23 numbers, this would value the company at $11, 15% downside potential below market at the time of writing.
Alas, with the points raised in this analysis, I am unable to convince the investment skeptic within myself to rate AORT a buy. I believe the market is still holding onto some hope with PROACT and Per-Clot, but I am not in the business of advocating hopeful investments. I need conviction, and data to back this up. There's an absence of this here. Net-net, I rate the company a hold at $11 valuation.
For further details see:
Artivion: Reaffirm Hold As Pressures To Growth Remain