2023-10-31 21:04:33 ET
Summary
- Doximity's stock has experienced a significant drop in value due to downsized revenue guidance for Q2 2024.
- The company's revenue growth has been impacted by a decrease in net revenue retention and a slowdown in customer spending.
- Despite the challenges, Doximity has positioned itself well in the healthcare market and has seen profitability improvements through cost optimization and the use of artificial intelligence.
- Investors should be on the lookout for management comments during the forthcoming earnings call.
- There are risks that the stock can fall further in the near term.
It has been a painful experience for those holding shares of Doximity ( DOCS ), a networking services platform for doctors as the stock plunged from above $35 to less than $25 in the second week of August. This was after the company downsized its revenue guidance for the second quarter of fiscal 2024 (Q2'24) whose results are expected on November 9.
Valuations have come down as the stock is now available for around $20.78 a share and the objective of this thesis is to show how it could become a long-term opportunity given the way it is adjusting to the post-Covid period by optimizing operational expenses. At the same time, it is also increasing the appeal of its products through artificial intelligence.
I start by checking the revenue growth in order to assess whether there are risks of the stock falling further, especially for those wondering whether it is the right time to buy.
Suffering from Lower Growth and Volatility
First, revenues for the first quarter of fiscal 2024 (Q1’24) which ended in June grew by 19.7% compared to the same period last year thereby beating management’s own guidance. This increase is mainly explained by 32 more customers contributing to above $100K of sales each as shown below, but this was partially offset by a decrease in NRR (net revenue retention), to 118% from 139% in Q1’23.
Now, NRR measures the ability of a subscription-driven company to retain income from existing customers. An above 100% figure is good but the declining trend shows that the healthcare platform operator is managing to squeeze less money out of its customer base through upselling, and is instead seeing them downgrading their plans. One of the reasons provided during the earnings call was that the shift to digital especially among pharmaceuticals has slowed, due to normalization following the ultra-high level of enthusiasm for the company's all-platform approach during Covid. Customers have also been experiencing budgetary constraints.
Coming back to forward guidance, the consensus topline estimates for Q2’24 have been revised downward 13 times by analysts during the last three months. The latest estimate now stands at $109.1 million and in case this materializes, it would represent only a 7% increase from the $102.2 million achieved for the same period last year. While this still means growth, it is a far cry from the nearly 100% peak (in revenue growth) achieved in mid-2021 as per the blue chart below, which coincided with the second wave of the COVID-19 pandemic.
Therefore, do expect further volatility in the stock price when results are announced in the second week of November in the event that there is no revenue beat. Also, with a valuation grade of D- , the stock is already richly valued based on all metrics, and, given its history as a growth company, a 7% growth rate will entail a substantial downgrade from what the company has historically achieved.
However, there are positives in view of profitability, and product positioning, which means that long-term growth potential is there.
Product Positioning and Profitability
First, this is a company incepted back in 2010 and throughout the years has appropriately positioned itself with its secured platform allowing healthcare professionals to connect, collaborate, and monetize their services. Tellingly, its medical directory of health professionals boasts 80% of America’s physicians which means that it is a major market player and benefits from a broad customer base to sell its services. Furthermore, talking about compliance which is key when dealing with patient records, the platform is compliant with HIPAA or Health Insurance Portability and Accountability Act standards, implying that communication and sharing of information is done in a secure and trustworthy manner.
Moreover, as shown in the orange chart above, Doximity has also been able to reduce operating expenses. This has in turn benefited profitability with the adjusted EBITDA of $46.6 million obtained in Q1’24, constituting a 39% YoY surge over the $33.5 million obtained last year. This has positively reverberated on both the cash from operations and FCF which increased by 28% and 31% respectively. However, lowering operating expenses could also imply spending less on marketing, which can in turn be detrimental to growth especially in a competitive environment, unless the firm can differentiate itself.
This is the case with, Doximity's distribution strategy including an online platform accessible via web and mobile applications together with strong partnerships with health establishments, hospitals, and medical associations. It also relies on referrals (Word of mouth) within the medical community to increase its scale instead of spending dollars on marketing, which means that it is a reputed service provider. Now, this is like having a brand name which in turn means a high level of customer loyalty and lower price sensitivity, or less probability of the customer base not shifting to the competition when Doximity increases subscription fees.
Furthermore, it has innovated with Generative AI with DocsGPT, a ChatGPT tool for doctors that aims to improve their productivity, namely by helping to streamline certain administrative tasks like drafting appeal letters to insurers which can be time-consuming. Looking deeper, this AI writing assistant works with the company’s free fax service and comes integrated with OpenAI’s ChatGPT.
Also, the fact that this AI tool is HIPAA compliant, has enabled the company to bag enterprise deals with three healthcare systems. These may also have been allured by the productivity potential of Generative AI which, according to a study by research firm McKinsey should generate $150 billion to $260 billion of value across the healthcare industry out of a total potential value of $2.6 trillion to $4.4 trillion by 2040. For Doximity this benefit could come in the form of an increase in NRR as existing plans are upgraded to include DocsGPT.
Valuations and the AI Value Add
This could in turn boost sales and reduce the price to sales multiples thereby making the shares more attractive from a valuation standpoint. However, the stock is already considerably overvalued compared to peers in the healthcare sector by over 165% (when considering price-to-sales multiples as shown below). Moreover, the executives do not expect more than a few million dollars of GPT-related income this year. Thus, sales should not meaningfully impact the topline for fiscal 2024 which ends in March next year, meaning that the P/S ratio should not be lowered enough to justify an investment at this juncture.
This is the reason for my Hold position, but this innovative technology certainly represents significant growth potential given the way ChatGPT took the world by storm within months of being launched. Secondly, by putting at the disposal of its customer base a product that is HIPAA compliant, Doximity ensures medical-grade encryption and secured communications. Moreover, with a strong balance sheet boasting a positive cash balance of $857.5 million (after excluding debt), the company can also acquire a health technology play to grow inorganically.
Thinking aloud artificial intelligence is just another example of the company's diversification strategy as it already generates sales from targeted advertisements to healthcare professionals, premium subscriptions, and talent search services which provide tools for healthcare recruitment as well as telehealth or remote services. It also generates revenue by acting as a data processor or processing data on behalf of customers and making these available to customers through dashboards as part of its Self-Serve platform.
More of a Hold
Still, it is important to gain further insights as to how the DocsGPT pipeline is progressing during the forthcoming earnings call before investing. The reason is that others like Teladoc Health ( TDOC ), a virtual (remote) care provider have also invested in AI to help in minimizing the administrative burden faced by health providers, namely through the automation of clinical documentation. The company has a collaboration with Microsoft (NASDAQ: MSFT ) for this purpose.
In conclusion, this thesis has shown that near-term pains subsist as growth could further suffer in case Doximity is not able to squeeze more out of its existing customer base given that Covid-led rapid expansion is now a distant memory. Also, momentum indicators also indicate that the stock could fall further as the price remains lower than the 10-day and 50-day moving averages. Therefore, it may not be the right time to put money in the stock.
On the other hand, this is a company making progress in optimizing its cost base while also investing in Generative AI which could result in more upselling. Also, by specializing in the healthcare domain, Doximity is able to convert a significant portion of the marketing spend made by its clients into revenues for them, as far as $17 in returns for every dollar spent. This is a high ratio and can be attractive in a period when inflation remains high and healthcare providers have to operate on razor-thin margins.
Finally, given the pains that have been inflicted on those holding on to the stock because of revenue guidance, it is important to wait for management updates concerning the topline for the third quarter (Q3'24) and fiscal year 2024 rather than resorting to buying the dip simply based on Doximity's strong finances and adding value to products through artificial intelligence.
For further details see:
Doximity: Adding Value Using AI But Faces Near-Term Risks