2023-08-07 23:20:00 ET
Summary
- InfuSystem reported mixed results for its 2Q23 earnings, with revenue beating expectations but a lower adjusted EBITDA margin.
- The company's revenue in the first half of the year exceeded initial guidance, indicating strong business growth.
- Despite the lower margin percentage, the company's hiring and training of new employees suggests that margins will stabilize and expand in the future.
InfuSystem ( INFU ), a stock I have covered for years, released mixed results last week for its 2Q23 earnings report and updated FY23 guidance. While revenue in the first half of the year has been a massive beat to their initial guidance (up 15% in 1H23 vs 8-10% guidance), the company ended up lowering its annual adjusted EBITDA (AEBITDA) margin percentage for the year (from 19% plus to 17-18%). Trading the day of earnings (Thursday, August 3) reflected these mixed results with the stock up initially on the day, but ending in the red. However, it seems the market started to figure out that INFU’s mixed results/guidance is actually quite bullish for both the near and long term, as I will show in this article.
In fact, I hope to show that by beating so significantly on the topline, INFU had no choice but to “miss” margin guidance for the bottom line (I put miss in quotation marks because the actual dollar amount of AEBITDA will likely still be the same or greater than under the original guidance, even with a slightly lower margin percentage). This is a fundamentally good “problem” for INFU because it means business has picked up significantly and the company needed to hire faster than expected. Soon, the margins will not only stabilize, but expand back to historic norms (above 20%). With that in mind, let’s move to the nuts and bolts to understand the dynamic INFU is facing and why it is extremely bullish for their future.
Revenue Strong, Margins Lagging
As noted, INFU originally guided FY23 revenue to be 8-10% above FY22. In tandem with that projection, the company expected AEBITDA margins to fall in the “19% plus” range. The 19% plus number, it should be noted, is below their historic margins, but was not surprising due to this year’s dynamic of onboarding their biomedical services partnership with GE Healthcare.
The GE Healthcare business is expected to be worth around $12M of revenue annually (itself representing about 12% revenue growth from the start of the contract) once all operations are up to speed. INFU anticipated ramping up that business over the course of about 18 months. As part of that ramp, INFU would need to hire and train new employees, as well as pay for their travel expenses. Because the revenue from said employees always lags those upfront expenses, INFU guided for “19% plus” margins this year, lower than the 20-22% investors would expect once all the new GE business is integrated.
So, what happened that the margin guidance needed to be lowered? Well, revenue picked up faster than initially expected as INFU and GE have been able to more quickly onboard that biomedical services business. In fact, in 1H23, instead of being up 8-10%, revenue is actually up 15%. Because the onboarding is going quicker than expected, the revenue is up beyond expectations, but in tandem with that, AEBITDA margins are down. And what I want to highlight here is that there is simply no other way this could have happened. In other words, INFU could have met their margin guidance, but that would have necessitated lower revenue. There is no viable scenario whereby INFU could beat on revenue guidance and then hit their margin percentage guidance. Why?
Because of the dynamic I mentioned earlier. INFU needed to hire and train even more employees in 1H23 than originally expected. This means that revenue goes up faster than expected, but so do expenses. In the long run, however, this dynamic will normalize and AEBITDA margins will once again expand. In the meantime, investors should note that the actual dollar amount of AEBITDA for FY23 will likely be about exactly the same—if not higher—than INFU’s initial guidance. However, because revenue is so much higher, when margins normalize in FY24, AEBITDA will be materially higher in FY24 than it would have been if INFU had merely hit its FY23 guidance. In other words, these 2Q23 results and FY23 guidance that, at first glance, appear to be mixed, are actually quite bullish in the grand scheme.
Admittedly, some investors might question management’s guidance, given their relatively recent, unexpected misses; but I believe management has learned a lesson.
Can We Trust Management Guidance?
When I first started following INFU, they gained a reputation of being a reliable “beat and raise” type company, meaning they would regularly beat their stated guidance in a given quarter or half-year and then raise the full year guidance. More recently, however, the company stumbled in that respect. To be fair, part of this change was largely outside management’s control. They simply overestimated how quickly certain contracts would be signed and the subsequent business would ramp. In addition, supply chain issues also threw off INFU’s results from their anticipated levels. Regardless, investors do not want excuses, they want results. And it is pretty clear from INFU’s stock price over the past few years that the market much prefers the “beat and raise” mentality of pre-2022 INFU.
In speaking with people familiar with INFU’s thinking, there is little doubt that INFU management learned a lesson and is now taking a more conservative guidance approach. The company even called that out on their recent earnings call linked above. Of course, we should never simply take management’s word for something when we have the ability to do the math ourselves.
While INFU is currently guiding for a “10% plus” revenue increase for FY23, I believe simple math would show that something closer to the 14% revenue growth is more likely. I come to that conclusion by running the numbers myself. If INFU revenue is stagnant, with zero sequential growth in 3Q23 and 4Q23, then INFU’s topline growth for FY23 would be 14%, well above the “10% plus” guidance. And although it is certainly possible that INFU’s revenue could drop sequentially, I cannot remember a single year since I have followed them where revenue dropped materially on a sequential basis. Actually, the norm is for their sequential revenue to increase. So, with that in mind, it appears INFU is indeed back to the “beat and raise” mentality.
Just as importantly, management seems to have made another subtle change. In late 2021, several investors were concerned that management was talking about too many opportunities (a good problem to have, but still a possible problem!). The worry was that INFU would “bite off more than they can chew,” getting involved in too many opportunities and losing focus. To some extent, that was part of INFU’s problem in 2022, although I still believe other factors I referenced above came into play also.
Regardless, the company now seems to be laser-focused on implementing one new opportunity at a time, smoothly and consistently growing the revenue and earnings, and ensuring that whatever they are implementing is done at the highest levels of quality. This year, then, the focus is on implementing the GE biomedical services business, which is going extremely well as the results show. But what happens after GE? Will INFU still have growth opportunities or will they flatline?
Future Opportunities
While the company is finishing its integration of the new GE business, expected to be fully onboarded during 1Q24, they are beginning to think about and lay the groundwork for future growth opportunities. I wish to highlight two.
Sanara MedTech & INFU Joint Venture
On the 2Q23 conference call, INFU elaborated on their new joint venture (“JV”) with Sanara MedTech ( SMTI ). In response to an analyst question, CEO Rich DiIorio indicated that both of these companies very specifically chose one another to enter the wound care space. For its part, SMTI offers what INFU believes is a groundbreaking product, the best on the market. INFU brings important relationships with DME and healthcare providers and third-party payers. By forming the JV, both entities fully committed to one another and functionally disincentivized each party from flirting with other possible partners in this space.
In terms of revenue and earnings projections, the only guidance INFU has given for this JV is that they expect to start earning material income by EOY24. In speaking with people familiar with this JV, I believe that both SMTI and INFU have been working in 2023 to lay all the necessary groundwork for their JV to start being financially successful in 2024 and beyond. Specifically, the JV needs to make sure that third-party payers will be paying for SMTI’s product which, of course, means that all of the billing details, etc., need to be ironed out before they go to market.
With respect to the size of the opportunity, I was quite surprised by my sources’ response. They indicated that this JV is not only the best opportunity INFU has ever had, but will likely be the best opportunity they will ever have! Both INFU and SMTI believe SMTI’s product can revolutionize the chronic wound care space. While it takes time for revolutionary products to gain market share, the opportunity is enormous—so much so that INFU seems to have put on hold its entrance into the lymphedema space, which previously had been the largest TAM opportunity the company had ever seen, to the best of my knowledge. Consequently, I believe in the next five years, it is possible for this SMTI deal to double the company’s current revenue in its “Patient Services” space (i.e. $60-80M in revenue).
Device Solutions
Prior to 2023, the “Device Solutions” division was referred to as “DME Services.” The new GE biomedical services business falls under the new “Device Solutions” category. Based on management’s commentary on the last earnings call, INFU has multiple opportunities to expand this business materially following the full implementation of the GE business (again, expected during 1Q24). Right now, INFU is homing in on the GE onboarding process, but next in their queue will be other significant opportunities.
I believe INFU has two broad directions they could go in this respect. They could expand their partnership with GE to include additional DME beyond the biomedical space, or they could take on similar biomedical business with other companies besides GE. It remains unclear to me what INFU will ultimately choose to do, but I am confident that opportunities exist and that INFU will focus on one major opportunity at a time, consistently and reliably chipping away at its now material pipeline of new opportunities.
Other Opportunities
The two opportunities above—the SMTI JV and new Device Solutions business—will be the focus of INFU in FY24. But beyond that, INFU sees opportunities in lymphedema and pain, just to mention two significant markets. Based upon conversations with my sources, I believe INFU’s pipeline is stronger and more robust than ever. That, combined with their disciplined approach to onboarding new business, leads me to believe the company could be a reliable, double-digit grower for years to come.
Risks
While I laid out the evidence for why I believe INFU is now back to a “beat and raise” mentality, the company still needs to re-earn that reputation. Until such time, there is the risk that “The Street” will not trust INFU and thus may not be reliable buyers and/or holders of the company’s stock.
Another risk is that INFU could be again overly enamored with all the opportunities in its pipeline and could lose focus. As stated, I believe management learned its lesson. Certainly, their public stance the past two quarters is that they will remain focused on the most lucrative near-term opportunities before moving on to others in their pipeline.
The final risk I wish to note relates to the SMTI-INFU JV. While SMTI likely does offer a revolutionary product, there is no guarantee the product will “sell itself.” INFU and SMTI will need to work hard to gain new business. This may take some time, and so revenue may not ramp as quickly as they (and I) hope and expect. Personally, I think there will be some sort of domino effect. Progress will likely be slow—until it isn’t. At some point it seems likely, at least if they ever succeed, that the JV will reach a critical mass whereby the dominoes really start to fall quickly. But will that be in 2024, 2025, or 2030?
Valuation
The typical valuation metric for companies in INFU’s space is enterprise value ("EV") over AEBITDA. I will, therefore, use this metric as my basis for valuation. Typically, companies like INFU trade for at least 8x EV/AEBITDA if they are a relatively stable business. For growing companies in this space, most especially those with organic growth like INFU, we can use 12x EV/AEBITDA to obtain a reasonable valuation. I would note that, in the past, when INFU was a reliable “cash cow,” constantly beating and raising and increasing cash flows, they traded for well above this 12x EV/AEBITDA multiple. All that to say that I believe the 12x EV/EBITDA I will be using is a fair and reasonable metric for INFU at this time.
I currently estimate INFU will earn at least $125M in revenue in FY23. This $125M assumes no sequential growth in 2H23. At 18% AEBITDA margins, that would put INFU at $22.6M in AEBITDA. At 12x EV/AEBITDA, that would put INFU’s share price at $10.85/share. Of course, that is only about 5% above the current share price.
However, as I noted, the $125M in revenue assumes absolutely no sequential growth, which seems highly unlikely based on past performance and future opportunities. Moreover, as we enter the back half of the year, the market will start looking towards FY24 expectations. While INFU has not given any guidance beyond FY23 at this point, I believe the opportunities in its pipeline point to another year of at least 8-10% growth, with margins normalizing to above 20%. In that base case scenario for FY24, I value the stock at around $14.50/share, or roughly 40% upside from here. Of course, I view these estimates as a minimum, as I believe the growth could actually be stronger.
On the risk side of the equation, I believe INFU is now materially and significantly de-risked. So, while I do not see INFU as a double or triple in the near-term (as is the case with most of my picks), I do see limited downside potential. Obviously, we must always be aware that in the case of a recession, all stocks might be temporarily hit. But in the case of INFU, the fundamental business is as close to recession-proof as we could ever hope to see. Because of this risk/reward scenario, I still maintain shares of INFU in my portfolio.
Finally, as it relates to the SMTI-INFU JV, this relationship has the potential to be a blockbuster for both companies. If that happens, then the stock is almost certainly a multi-bagger from these levels. Given INFU’s relatively recent stumbles, however, I am being more conservative in my base case analysis here.
Conclusion
INFU’s mixed 2Q23 results and FY23 guidance are actually a sign of bullish times ahead for the company. After stumbling throughout 2022, the management team seems to have learned from mistakes and is now laser-focused on implementing key opportunities before progressing to other new opportunities in the pipeline. Moreover, they seem to have returned to the old “beat and raise” mentality that the market rewarded in 2021. With multiple near-term, and even more long-term, prospects for success, I rate INFU as a buy with a near-term price target of $14.50/share.
For further details see:
InfuSystem: Mixed Q2 Results Are Actually Bullish