2023-06-23 00:25:20 ET
Summary
- Establishment Labs Holdings Inc.'s recent launch of Mia Femtech in Japan could present a significant opportunity in the breast augmentation market.
- ESTA's valuation now hinges on its ability to drive Mia Femtech units in Japan, in my view, amongst other drivers.
- The next 2-3 quarters will be critical in determining the company's growth trajectory.
- Valuations of 8x forward sales are currently unsupported by fundamental data. Reiterate hold.
Summary of investment thesis
Following my March publication on Establishment Labs Holdings Inc. (NASDAQ: ESTA ) there have been notable updates to the critical facts. The. company's latest numbers also are more constructive. Chief to the developments are the company's Mia Femtech launch in Japan. I had discussed this potential catalyst ad nauseum in my last 3 ESTA publications, noted below:
- More Constructive, But Not At 10x Sales
- No Change To Hold Rating Following Latest Numbers
- Flat Earnings, Return On Investment Keep Buyers At Bay
Alas, this report will dissect all of the moving parts in the ESTA investment debate now that the offering is turning more serious. For one, the company's valuation now hinges on its propensity to drive Mia Femtech units in Japan, which will involve capital investment and potential growth in tangible assets. Investors are paying up to 8x forward sales on this and look to be valuing the company on asset and sales factors. Hence, this is central to my analysis as well.
Whilst I am turning far more constructive on the company, an entry now would be speculative. Instead, I am playing for a break after the company's Q2 and Q3 FY'23 numbers to observe the early successes (or failures) of its expansion into Japan, a highly lucrative market that is currently underserved in breast augmentation. Net-net, reiterate hold, awaiting further developments on the company's latest catalysts.
Figure 1. ESTA consolidation back through support [weekly chart]
Critical factors forming ESTA hold thesis
After the recent Japan developments, along with an update on the firm's Q1 financials and balance sheet, I've identified a number of critical facts that underpin a neutral view. These are on fundamental and sentimental grounds, showcasing negative and positive points (hence the balanced view).
1. Fundamentals are balanced
An appraisal of ESTA's top-line fundamentals illustrates the growth it has delivered since 2016. Sales are up from $29mm to $209.4mm, having advanced another 34% YoY (using TTM figures to calculate "2023"). Straight away, management are calling for $200-$210mm in sales this year, ~30% upside at the upper end. Critically, there may be a surprise on this if the company converts on its Japan investments (discussed later). My numbers call for $217mm at the top for FY'23 on $199mm gross profit, stretching to $286mm by FY'24, where I could see ESTA printing an operating profit [see: Appendix 1].
Table 1. ESTA has grown revenues each year into 2023 ((TTM)), with reason this will continue now given the Japan entry
Linking the fundamentals to the market's valuation of ESTA, note the following:
- It appears the market is valuing ESTA on sales and asset factors as of 2023. This makes complete sense, given its growth route will involve capital investments, growing operating assets (including inventories and receivables) and bringing sales volume in on its products.
- Given that, the 25%+ growth projected in revenues could be a strong factor in driving additional market cap.
The overarching questions- has the price already got there at 8x forward sales? How much growth is priced into that multiple?
Figure 2. Market valuing ETSTA on a combination of sales and asset factors
Circling back to the quarter, the identifiable tailwinds on my notes are the following (in no order):
- Market expansion. Any expansion is exciting in my books, provided all the cards stack right. the introduction of Mia Femtech to Japan presents an undeniably strong opportunity for ESTA, should it convert over the long run. By addressing the unmet needs of women in Japan through a minimally invasive breast augmentation procedure, the company opens doors to a previously untapped market segment, as this is not the convention there Hence, it is seeking opportunities with substantial growth potential- a good sign, in my books. Now it is execution time.
- Related to point (1), the "route to market" in Japan is through planned marketing campaigns and partnerships with established clinics. It effectively aims to establish a new surgical category. You're up for a challenge, trying to disrupt any market this way- but first-mover advantage does exist, as well.
- ESTA's financials are shifting higher, thus, the next stages are absolutely critical in forming the long-term investment view . ESTA clipped Q1 turnover of $46.5mm, up 21% YoY. This was also a quarterly record and therefore demonstrates the firm's fundamental momentum. As mentioned earlier, management are looking to do $200mm-$210mm this year, 24%-30% growth, so if it keeps this up over say, 3-years you're looking at a tidy growth in revenues from $200mm to $440mm (200x1.3^3 = 440mm).
- Finally- I'd note the margin gains on asset utilization. Despite increased overhead and labour costs on its revenue clip, ESTA pulled this to gross margin of 64.7%, flat YoY. The firm has been hastily stretching its gross higher since 2019, from 55% to the c.65% last quarter.
Essentially, it would appear ESTA is on the precipice of either a steep launch curve or one of a continued plateau. I wouldn't say the firm is going to slow down at all, or run into any major liquidity hurdles. It has $42mm in cash and is running through ~$5mm in cash burn in some quarters but takes this back on inventory and cash collections.
2. Further analysis
As mentioned, the introduction of Mia Femtech into the Japanese market presents a promising occasion for ESTA in my professional opinion. I had rhapsodized this point extensively in the past 2 publications. I also noted that attention to this development does not seem to be commensurate with its significance, not at the moment anyway. However, my personal sentiments are of no consequence. What counts is the market's perspective. When my investment cortex tells me the market is and accurate judge of value and future expectations, I sit and listen, even though I know it is sometimes wrong.
Over the last 3 months, there have been 2 analyst revisions , which, in my view, is insufficient to attract investment. In addition, 3 negative revisions surpass this figure anyway. As a result, the market sentiment is currently low in my view. Consequently, it is necessary to arrive at a consensus regarding the next course of action. To achieve this, more data is required, especially pertaining to the economics of the Japan market, as this will involve developing a clear investment and cost-containment strategy.
Options activity reflects a balanced outlook, with significant open interest in both calls and puts. Specifically, there are 368 contracts at $70 strike on calls, July expiry; this is mirrored in the positioning on the puts ladder. This positioning indicates a balanced breadth in investor sentiment, supporting a neutral view.
Lastly, momentum is low, with the stock trading below all moving averages. This suggests an inability to breach key psychological levels. Momentum, therefore, is a reflection of the current investor mood and is echoed by analyst/commentator sentiment. Investors are currently speculating on the stock. In my opinion, this supports a neutral sentiment.
Figure 3.
Valuation and conclusion
The current forward sales multiple of 8x may explain the lack of momentum, as the potential for further upside from this already high base appears limited. To justify the current premium of 129% over the sector, significant sales growth is required. The scale of growth required also appears unlikely. I assume sales of $286mm for FY'24 and given a blend of FY'23 and FY'24 I get to $65 per share in equity value at the sector multiple of 4.3x. Accordingly, the current valuation appears unsupportive of a buy rating. Also unsupportive, is the quant system's rating of hold . I would suggest that, at this stage in the firm's life cycle and the absence of earnings these quantitative readings are invaluable in forming an investment view. The fact it can be consolidated into objective viewpoints and compared to the sector and industry peers does so much of the heavy lifting on our behalf. Hence, it is supported hold on this basis too.
Figure 4.
In summary, the market has yet to recognize the potential opportunity for ESTA with its Mia Femtech launch in Japan, which could be a significant factor in changing ESTA's investment outlook. However, ESTA has not yet capitalized on this opportunity either, and thus, the next 2-3 quarters will be critical in determining how the story unfolds. Moreover, current valuations are unsupportive without the economic data to run by. My assumptions call for $217mm at the top in FY'23, ahead of management. I would strongly urge that the next 2-3 quarters are a critical inflection point in the company's growth cycle. If it converts on recent developments, I would be turning far more constructive. Net-net, reiterate hold for now.
Appendix 1. ESTA Forward estimates [Note: from March 2023, estimates are provided in a rolling TTM format].
For further details see:
Establishment Labs: Mia Femtech Approved In Japan, Far More Constructive