Summary
- Exact Sciences is beginning to stem losses and is continuing to grow revenue at a reasonable clip.
- Despite this, GAAP profitability is still far into the future, and the 2023 guidance is mediocre.
- EXAS stock does not seem compelling at these levels.
Thesis
Despite some positive developments, we do not believe that Exact Sciences ( EXAS ) is attractive at these levels. The company remains unprofitable and their 2023 guidance is mediocre.
The Good
Let's start with the good things that Exact Sciences reported in Q4. Exact Sciences has done relatively well to continue to grow while stemming operating losses. In their fourth quarter they were able to grow revenue by 17% and reduce their operating losses by 46%. These growth numbers are even better if investors exclude COVID testing revenue.
The good news is that their decreasing losses prove the model has some amount of operating leverage. The problem is that they need to continue to grow revenue in order to realize this operating leverage and their forward guidance suggests that revenue growth in 2023 will be significantly lower than in 2022.
The Bad
Exact Sciences remains GAAP unprofitable and that doesn't appear to be changing anytime soon. This would be fine if their guidance wasn't so light, and if the market wasn't in such a risk-off mode.
It is expected that their COVID testing revenue will decline, and this isn't a knock on the company. The projected growth (or lack thereof) in their Precision Oncology segment is however a valid cause for investor concern. Most of the projected growth is coming from their Screening segment (comprised mostly of Cologuard). The company is guiding for 9.8% revenue growth at the midpoint, which simply isn't going to cut it in this environment. This is especially true when the company is still unprofitable and is relying on continued revenue growth to reach scale. The longer that those future cash flows take to become available the less they are worth in the present. The company has more than enough cash to cover their burn rate until they achieve operational self-sufficiency, but this isn't the primary concern here. With Exact Sciences it isn't a question of potential bankruptcy, it is a question of whether the company can achieve profitability in a time frame that is soon enough to justify the current price. At the moment we do not believe that they can, and we view the stock as being overvalued.
Also of note is their sizable debt pile of $2.2 billion. Some bullish investors may point to the fact that this debt is convertible, but at the end of the day it will negatively impact investors either through dilution or reduced cashflows available to equity holders. The debt pile further reduces the present value of the company.
The Ugly
The lurking possibility is the potential for other companies to pressure Exact Sciences' margins once they finally become profitable, reducing the value of those future profits. Investors can point to their many advantages, whether that be first mover, a recognizable brand, and intellectual property. While these are all valid points, the possibility for them to be forced into a price war remains. Different types of screening solutions may appear in the future that are either more cost effective or more functionally effective than Exact Sciences' solutions.
Price Action
On a five year basis Exact Sciences is essentially flat. The stock has been on a tear over the past few months and is up over 100% from the lows. It's possible that momentum carries the stock higher in the short-term, but the current price seems overextended on a fundamental basis.
Valuation
While Exact Sciences certainly looks cheap compared to its historical multiples, this is still an unprofitable company with a significant amount of debt. The free cash flow to equity potential isn't high enough here to justify the multiple, especially when compared to the many unprofitable software companies that are trading on a similar price to sales basis, yet have much higher growth numbers and a net cash position. Of course, Exact Sciences isn't a software company, but the point is that every investment is a question of whether or not there is a better place to invest the money for the given risk profile. For the risk investors are taking by investing in Exact Sciences, they could be getting a better reward elsewhere for that same amount of risk.
Risks
A risk to this bearish thesis is the potential for the public to become much more interested in taking proactive steps to screen for potential health issues. This could lead to Exact Sciences growing their revenue in rapid fashion and achieving profitability quicker than most expect. A swift increase in bullishness around the sector could even lead to the company being acquired.
Another risk is that Exact Sciences could find additional efficiencies within their model, leading to better operating results without the need for faster than expected adoption of preventative health solutions.
We believe that this is a show-me story and that while the company may be able to put up results that justify their current valuation, we find it unlikely.
Key Takeaway
We believe that even though Exact Sciences is showing good progress towards realizing the operating leverage in their model, their growth and ability to achieve profitability is too slow to justify the current valuation. The debt load isn't great. If investors are interested in investing in unprofitable companies that are valued on a price to sales basis, there are much better companies to look at with far higher revenue growth numbers and net cash.
For further details see:
Exact Sciences: Trending In The Right Direction, But Not Enough