Summary
- Establishment Labs' top-line growth was commendable with upsides in key markets, especially Brazil.
- FY23 is undoubtedly a major inflection point for the company, with numerous product launches set.
- Management seems constructive on forward-estimates, looking for $500mm in revenue by FY26.
- Valuations are unsupportive, and I'd be looking for more upside in the risk/reward calculus if paying 10x sales.
- Net-net, I reiterate ESTA as a hold.
Investment summary
Following my last publication on Establishment Labs Holdings Inc. (ESTA) in December, titled "No change to hold rating following latest numbers" the company's Q4 numbers paint a more compelling picture within the investment debate. Chief to this, is the company's 4th and final pre-market approval ("PMA") for its Motiva breast augmentation last week. This marks an important milestone for the product's commercialization in the U.S., and could be a meaningful catalyst looking down the line. Added to that, the company is constructive on its longer-term growth outlook, projecting a 33% geometric growth rate at the top-line to $500mm going into FY26, and, using the CEO's language from the call , that "many layers also suggest that this target is well supported, even conservative, and that growth will continue for many years beyond 2026" . Further, the stock has caught a reasonable bid off its FY22 lows and rallied along a well-defined line of support as investors continue to reposition against risk assets into the new year. Net-net, I am certainly turning more constructive on ESTA, and investors appear to be doing the same by the looks of the chart below. However, I'm awaiting more evidence on its execution of key product launches this year, and the uptake of these in its key markets. I'd see the stock rating higher to ~$86 at 10x sales. But, at this ~20% margin of safety, I'd prefer to have a higher risk/reward calculus to justify this valuation. Hence, I reiterate a hold rating for now.
ESTA vs. benchmark, corresponding equity beta, FY22-date
ESTA Q4 results analytics
There's been a few key updates in ESTA's growth engine since the last publication that are worth noting. First of these, are the company's Q4 numbers. There were several notable takeaways from the quarter and these relate to growth, the distribution of revenue in ESTA's key markets, and the growth outlook it has looking ahead. Starting with the earnings print itself, I made note of several data points. To name a few:
- It booked a 24% YoY growth rate in top-line sales to $43.8mm, factoring in a ~295bps FX headwind to the result. Disaggregating this further, distributor sales contributed 63% [$27.6mm] to the turnover, whereas direct sales made by the company attributed just over $16.2mm in revenues. As a side note, for the full-year the company recognized $161.7mm in turnover, a 28% YoY increase. These are good growth percentages in my opinion, and here's why. First, they are sustainable and align with management's ambitions for expansion discussed earlier. Second, they aren't so high as to be too high of a base to work from in subsequent years. Finally, it also evidences robust uptake of the company's products and services within its key markets [discussed in point 3], and provide a good springboard for the company to work from looking ahead.
- Turning back to the quarter, I'd point out the company's gross margin remains robust at 64.3%, but still compressed ~430bps YoY to a $28.2mm gross profit, ~300bps of this contraction attributed to FX headwinds. One key to this, is that the company had most of its inventory denominated in Euros, hence, with the repricing of the EUR/USD cross rate, had to revalue its inventory on the balance sheet, therefore impacting its COGS for the period. Understandably, with the increase in turnover the firm also booked a 26% YoY headwind at the SG&A line, but I'd also highlight that a good portion of the spend was diverted to its upcoming launches of Mia and Motiva. This, and upside in R&D, arguably could be classed as strategic investments in my opinion and therefore could be reclassified as such. Especially given that I see ESTA at a key inflection point with these launches, as discussed later in this report. Moving down the P&L, the quarterly operating loss came in to $13.1mm and it pulled this down to a net loss of $13.2mm for the quarter.
- Breaking down the regional highlights, the star performer was its European footprint, clipping 28% of global turnover, whereas APAC and ME markets were up a combined 40%. Curiously, however, the company's largest single market is Brazil, accounting for 14.6% of turnover [Figure 1]. Gonzaga et al. (2015) explain that breast cancer mortality rates are lower in Brazil than in many developed nations such as the U.S., whereas data presented by The Economist from GLOBOCAN 2012 outlined that a high incidence of Brazilian women will develop the condition before the age of 75. Gonzaga et al. also surmised that there aren't as many solutions for those with the condition in the realms of treatment after diagnosis. Meanwhile, findings from Caleffi and co-authors (2020) demonstrated that 5, and 10-year overall survival rates for women with breast cancer in Brazil were 93.5% and 83.8%, respectively. In addition, data presented by Orlandini & colleagues (2021) exhibit that breast cancer prevalence amongst the <45 years old populous was higher than other regions [see: Figure 2]. The culmination of this data suggests that ESTA has a high propensity to capture market share in Brazil, and so it's therefore unsurprising after reviewing the literature to see it being a) the company's largest single market, and b) the double-digit growth rate there.
Fig. (1)
Data: Author, data from ESTA 8-K
Fig. (2)
Data: Oladini et al. (2021): Epidemiological Analyses Reveal a High Incidence of Breast Cancer in Young Women in Brazil, see: "FIGURE 1"
FY23 a key inflection point to the growth route
Based on several factors FY23 looks to be a major inflection point for ESTA's growth engine. As stated earlier, the company's PMA submission for its Motiva implants segment in the U.S., in addition to its Motiva launch into China. This includes the [Motiva] Round Plus, Egonomix and Ergonomix2 implants. Notably, the key differentiator between these implants versus competitors on the market, are to do with the flexibility and shell quality that is potentially less prone scar tissue and adhesions. Further, this also includes the Motiva Flora tissue expander, a product the company continues to roll out into its key markets outlined earlier.
Extending from this, it's also important to emphasize that ESTA signed its first clinical partner within its Mia Femtech segment, Seishin Plastic and Aesthetic Surgery in Japan. The company operates 10 " aesthetics practices" in Japan. According to ESTA: "[Seishin] will first offer Mia under two locations in Tokyo; their flagship clinic in Roppongi and their newest clinic in Ginza. Seishin is one of the most prestigious aesthetic practices in the world, and we are so happy to have them as our first partner in the global rollout of Mia. Our practice development and medical education teams are actively engaged with them in preparation for a launch". Hence, I'd expect this to be a major factor to ESTA's growth engine should this collaboration take off at early pace.
With respect to revenue growth, management are looking at strong upsides at the top-line into FY23. My breakdown is as follows:
- FY23 revenue growth of 24-30%, calling for $200-$210mm at the top-line, $205mm at the midpoint [Figure 3].
- Early uptake of its Mia product in China, especially with the reopening from Covid-19 there. It looks to a steady contribution in FY23, but accelerated growth from thereon in.
- Gross margin flat with FY22, which could be a good sign given the intended product launches, inflation, and cost of inventories that are associated with growing its top-line. This, in combination with the company's new production facility suggest the flat gross margin could be a potential tailwind in my estimation.
- Initial phase of the Sulayom campus to begin commercial production.
Combined, these are 4 growth levers that have the potential to be a meaningful contributor to top-line growth. Whilst I'm not expecting profitability from the company into the near-term, it is important the company embarks on a significant growth route in order to get there sooner or later. Subsequently, I am turning more constructive on ESTA in this regard.
Fig. (3) ESTA revenue ramp, showing FY23E revenue estimates of $205mm at the midpoint
Data: Seeking Alpha, ESTA, see: "Revenues"
Valuation
It's difficult to provide a well-rounded valuation for ESTA at this stage given a) the lack of profitability, and b) the lack of earnings growth to go by. Nevertheless, the stock is trading at a premium to the industry at ~10x forward sales. Paying this multiple we'd expect ESTA to grow revenues by that amount over one's horizon period. This would be ~$1.6Bn based on its FY22 full-year numbers. Question is, would it get there within a 5-year window? In my estimation, this is a big ask of ESTA and likely would still represent a premium, even if it did manage to hit $500mm in sales by FY26 as it hopes for. However, there's a couple factors to consider. The new product launches can certainly accelerate the top-line growth over this time. Second, the China reopening may or may not be a strong tailwind adding to this. Third, and to the contrary, as equity investors, we don't get paid from sales growth, only from residual earnings that are distributable after reinvestment into a firm's future growth. So the investment debate is balance for ESTA. Assigning the 10x multiple to management's $210mm in top-line projections for FY23 derives a price target of $86, ~20% margin of safety at the time of writing. This is certainly more constructive, but not enough risk reward in my estimation to justify a buy. Say you allow for a 15% pullback from your purchase price as risk management, in this case, letting ESTA slip to ~$62. Ideally, you'd want a risk:reward ratio of 1:3, otherwise, 15%:45% return potential. If the stop-loss is tighter, at 8% say, you'd still want ~25% upside potential as a price target in my estimation. This supports a neutral view. Further, the quant ratings system has ESTA placed at a hold, as further evidence of this posture.
Fig. (4)
Data: Seeking Alpha, ESTA, see: "Ratings"
In short
I am certainly turning more constructive on ESTA as it advances along its growth route. In my opinion, FY23 is a key inflection point for the company. Investors are looking to a number of product launches, and growth in the company's key markets. Combined, there is a chance the stock can push higher, towards a target of $86 at 10x sales. I think there is a 20% margin of safety from this price, and I'd be looking for a higher reward in the risk/reward calculus in order to pay this multiple. Hence, whilst trigger-ready on this name, I recommend ESTA as a hold for now, awaiting data from its new product launches to change the posture.
For further details see:
Establishment Labs: More Constructive, But Not At 10x Sales