2023-08-08 08:16:20 ET
Summary
- Masimo Corporation faces competition in the healthcare equipment industry and its valuation may be getting out of hand.
- The company's preliminary results for Q2 2023 were below expectations, leading to a significant decline in share price.
- Margins are decent overall, but the negative free cash flow and low cash reserves may hinder future growth and lower the company's valuation.
Investment Outline
As a company in the healthcare equipment industry, Masimo Corporation ( MASI ) does face a lot of competition as they aim to manufacture and market their products above everyone else. The growth has been impressive for the business so far, but I fear that the actual valuation of the company is getting out of hand. The p/e sits at 30 and 2023 is likely to post a down year as EPS contracts, a result of a difficult market and higher interest rates, among other things.
Overpaying for a company will often set you back sometime for a position to start generating a return. For MASI I think we are overpaying right now and seeing a clear shift in the EPS trend would be necessary for me to change my stance on the business, which right now is a hold. The company has gathered up an international market and now focuses on monitoring technologies and automation solutions. Margins are decent overall apart from the negative FCF. Some weeks ago the company announced preliminary results for the second quarter of 2023 and shortening what was said, the results weren't that impressive with a struggling customer conversion. This caused a significant decline in the share price and spooked the market. Below we dive deeper into what this means going forward.
Recent Developments
As mentioned above, on July 17 MASI announced preliminary results for the second quarter of FY2023. The revenue expectations are in the range of $453 - $457 million. This is below what the expectations were for the quarter and resulted in a nearly 20% drop in share price. MASI was already trading at a quite rich valuation and the news of this certainly doesn't help any buy case out there for the company.
Company Sales (Earnings Presentation)
Some of the key points that caught my eye were the fact that MASI is struggling to have decent customer conversion rates. The new customers who have contracted to switch to Masimo were less than what the management was expecting. This seems to have been due to labor shortages, a challenge that troubles many industries in the US and internationally.
Besides this, some challenges are hovering above the margins and seeing a QoQ decrease in the upcoming Q2 report on August 8. These challenges include continuously high labor costs and strained budgets as the interest rates in the United States and other countries have increased. This has made borrowing and debt more expensive and will likely continue to hurt the industry I think.
But everything is not all bad for MASI right now. They are still growing new customers at record levels and their market share is steadily increasing. It seems that MASI is a growing company than anything else and hiccups like this are likely to cause severe changes in the share price. But for the risk-tolerant, the company might still look appealing. For me though, I want resilient margins and an environment with more capital circulating - a lower interest environment would likely cause that.
Earnings Preview
Going into the earnings for MASI on Tuesday 8 after the market closes I think investors are best to stay away right now. The preliminary results we got underscore some of the difficulties we have seen the company experience so far into 2023.
EPS estimates sit at $0.64 for the company, representing an over 50% YoY decline. I think we may see a miss on this part as interest rates and higher costs are taking a toll. Buying into earrings seems very dangerous and a big reason for my hold rating. A disappointing report will likely send the sock price lower and open up better buying opportunities instead.
Looking at where the price might land, I don't think it's unreasonable to assume the stock might drop 10 - 15% at least, that seems to be what most companies are dropping these days even on small misses. What I think could cause for a positive move for the share price is if MASI managed to pass expectations on new customer growth, indicating this is only a short-term headwind likely to soon disappear.
Margins
Margin Profile (Seeking Alpha)
The margins of MASI are quite decent as I said earlier on but the lacking FCF margin is creating some hurdles down the road I think. If MASI wants to quickly expand and improve its market share, then maintaining a sound FCF margin is going to make it so much easier. The company does have a history of acquisitions but that needs to be more widely available I think. The cash reserves for the company are at some of the lowest levels at $174 million. This might create a constrained situation for MASI going forward as a lack of capability to improve the balance sheet might be cause for a lower valuation.
Valuation
EPS Estimates (My Own Estimates)
As I have made clear throughout the article I think that the valuation of MASI is quite high now, despite what might be steady growth over the long term. Investing in companies that are undervalued brings more immediate potential upside and I don’t see that with MASI. In the chart above I think they can achieve a 12% EPS growth over the next couple of years. If interest rates decrease and hospital budgets grow then I see it as likely to customer growth will accelerate. This isn't enough to make MASI a buy yet though. An 18x earnings multiple is slightly below the sector and I use that to get some margin of safety to an investment. Unfortunately, this isn't enough to be anywhere near the current price or above it. Instead, MASI is trading nearly 55% above where I would like it to be for an investment. The positive outlook at strong customer growth so far though lends me to least rate it a hold for now.
Risks
When it comes to assessing the potential risks associated with this company, a notable factor that demands consideration is its significant reliance on major product lines, which not only contribute substantially to its sales but also play a pivotal role in defining its market presence. One particularly noteworthy cornerstone in this context is the Masimo SET platform, which holds a prominent position within the company's product portfolio.
Delving deeper into the realm of healthcare, a pertinent risk emerges in the form of escalating costs that have surged in the market over recent years. This cost surge has precipitated the introduction of new legal conditions and regulations that companies must navigate, adding an extra layer of complexity to the industry landscape. These evolving market dynamics, coupled with the potential for patient complications arising from the utilization of the company's products, could significantly impact its operational trajectory.
Investor Takeaway
The primary results that MASI posted recently showcase the fact that customer growth is slowing as labor costs increase and hospital budgets are constrained. This caused a significant decrease in the share price and I think it will continue to trade downward going forward. As long as interest rates remain high it seems likely that MASI will struggle to grow its top and bottom line at the historical growth momentum it has had. However, the market share the company has taken seems likely to stay, and I think the long-term still looks very good for MASI, and a hold rating is my view of them currently.
For further details see:
Masimo Corporation Not Looking Good Going Into Q2 Earnings