2023-03-06 14:26:13 ET
Summary
- AxoGen's revenue tracked a little ahead of expectations in FY'22, and the company has recently seen some momentum with surgeons increasing their usage of the company's grafts.
- Between the RECON results and a recent meta-analysis of past studies, the clinical argument for using AxoGen's products (good efficacy, patient outcomes, and costs) continues to strengthen.
- AxoGen shares look undervalued relative to what the market often pays for mid-teens revenue growth, but the company must step up account volumes and revenue growth to see a rerating.
The real market potential for surgical nerve repair remains controversial, with a meaningful gap between potential procedure counts and actual procedure volumes, particularly for newer options like allografts, as surgeons frequently stick with what they know. That has proved to be an ongoing challenge for AxoGen ( AXGN ), and while the company made progress in 2022 and hit most of its operational targets, the Street has yet to really reward the progress.
These shares are about where they were a year ago when I last wrote about the stock , and while that’s disappointing, it is at least better than the performance of the underlying med-tech sector (down about 10%) and rivals like Integra LifeSciences ( IART ) (though nerve repair is a small part of IART’s business). That flattish-to-down performance comes despite slightly better revenue performance, ongoing growth in higher-volume accounts, and a successful pivotal clinical study. Given that AxoGen should be able to generate another year of mid-teens or better revenue growth, I do still see scope for rerating from here.
Waiting For New Guidance
Management offered preliminary numbers for the fourth quarter about two months ago at a major sell-side conference, with fourth quarter revenue coming in up about 16% year over year and down about 3% quarter over quarter in what is typically a soft seasonal quarter. With that, final 2022 revenue should come in about 9% higher than the prior year and about $5M (4%) higher than my expectation for the year at this time in 2022.
AxoGen management has been careful on guidance, but hasn’t backed away from mid-teens revenue growth guidance for 2023. Gross margins have been fairly steady in the low-80%’s, and I expect little change here. I don’t expect AxoGen to become profitable at the operating income line (at least as per GAAP), though, as I believe the company is likely to at least modestly increase its investment in sales and marketing. Profitability on an adjusted EBITDA basis looks more plausible, but I don’t expect meaningful (10%-plus margin) EBITDA for at least three more years.
Looking To Accelerate The Base Business
I see multiple drivers continuing to contribute to improving results. First, procedure volume normalization continues to offer a tailwind, as improved staffing levels allow hospitals to resume more typical operations, and that includes more complex and time-consuming cases like nerve repair. Integrating new surgical approaches (like a switch to allografts) isn’t particularly attractive when you’re already pressed on capacity, and I do think normalization of staffing levels will make facilities and surgeons more amenable to broadening the scope of their procedures to include more allograft procedures.
Second, the company continues to pivot its market effort toward its own active user base, seeking to drive increased adoption and convert more of these “active users” (meaning 6 or more purchases over a year) into core accounts (orders of $100K or more in the trailing 12 months). One of the realities with newer surgical technologies and techniques is that no matter what is presented in clinical research or demonstrated at conferences, surgeons often conduct their own “mini-trials” and wait to see how the approach performs. I believe this is at least part of the reason why AxoGen has been seeing improved conversion of active accounts to core accounts in recent quarters (up 18% in Q4, up 17% in Q3), and I believe a more focused marketing effort can help spur that process forward.
Third, the company continues to amass a meaningful collection of clinical data supporting the expanded use of the company’s allograft products for nerve repair, with clinical data pointing to non-inferiority to autografts and superiority to manufactured conduits. While I did just note that surgeons often insist on conducting their own “mini-trials”, the reality is that most wouldn’t bother if the reported clinical data were poor, so clinical data is still an important part of the AxoGen story.
AxoGen posted the long-awaited RECON study results over a year ago, confirming the superiority of the Avance allograft to manufactured conduits in the repair of nerve damage to the fingers. The study showed superiority to manufactured conduits for return of sensory function in long repairs and in time to recovery, while also showing a lower likelihood of persistent pain post-procedure. This study will be the cornerstone of a Biologics License Application (or BLA) with the FDA at some point in the first half of this year, helping to establish a wider regulatory moat around the Avance business.
AxoGen more recently (early January of 2023) announced the publication of a meta-analysis of 35 peer-reviewed studies covering over 1,500 nerve repairs using the company’s allografts. In lengths up to 70mm, recovery rates, sensory recovery, and motor function were comparable to autografts and superior to conduits.
As a reminder, achieving superiority to autografts (nerve tissue taken from the patient) isn’t really a credible goal in the nerve repair market. Instead, what companies like AxoGen (as well as Integra and others) build their business around is that allograft (and manufactured conduit) procedures are faster (no need to harvest the autograft), more cost effective (there’s generally no separate reimbursement for harvesting the graft), and better for patients, with similar clinical outcomes, less pain, and less risk of complications (like infection and neuromas at the harvest location).
The Outlook
Changing surgical practices takes time and some surgeons will never make the switch. Likewise, there are still risks that growth opportunities like breast reconstruction will never develop as hoped. While lack of sensation following a breast reconstruction procedure is often reported as a significant issue among patients undergoing to procedure, neurotization takes time, costs money, and represents potential complications. It is, however, also a way for surgeons in a competitive market to stand out from each other and drive more procedure volume, and I do believe this is a $50M/year or more opportunity for AxoGen.
Despite a little outperformance in 2022, I haven’t changed my numbers all that much. I’m looking for mid-teens growth in FY’23 and acceleration to high-teens growth in FY’24 and around 20% growth in FY’25 as the company leverages its clinical data and continues to convert more “casual” active accounts into core accounts. Over the long term, I expect mid-teens core annualized revenue growth, getting the company to over $500M in revenue in FY2030 and positive free cash flow in FY’26.
AxoGen stock looks undervalued on both discounted cash flow and a growth/margin-driven EV/revenue approach, and I believe the shares can double from here. For that to happen, though, there will have to be improvements in revenue momentum in FY’23 and FY’24. One of the persistent bear arguments is that the market simply isn’t as large as bulls believe and that AxoGen has already largely penetrated the market of surgeons willing and interested in doing these procedures in meaningful volumes.
The Bottom Line
AxoGen hasn’t really worked out as an emerging growth med-tech story, and perhaps I’m simply being stubborn in sticking with the story. I do believe there are sound arguments for using AxoGen’s allografts, though, and that data will drive more surgeons to adopt the procedure. I also see AxoGen has a relatively simple tuck-in acquisition for companies in the wound care/surgery space. Readers should approach this as a high-risk proposition, with meaningful doubts about the company’s ability to achieve revenue and margin/profitability targets, but I do think the current valuation underrates the emerging growth potential.
For further details see:
AxoGen Making Progress, But Not Enough To Drive A Meaningful Rerating Yet