2023-09-28 12:07:57 ET
Summary
- QDEL's stock has been declining, with $2+ billion wiped off its market cap over the past 15 months, and it is now approaching long-term support.
- The company is facing cash-flow headwinds, with reported negative operating cash flow in Q2 this year and negative GAAP earnings projected for Q3.
- COVID-related revenues have been disappointing, and the CFO expects lower gross margins for fiscal 2023 as a result.
Intro
We wrote about QuidelOrtho Corporation ( QDEL ) back in July of last year when we expected the newly formed entity (Quidel & Ortho Clinical Diagnostics) to continue its rally to the upside. Our bullishness was based on the significant synergies expected to come off the merger and the sizable number of cross-selling opportunities expected to open up as a result of the deal. Furthermore, it was expected that the new entity would make meaningful gains in the likes of the growing 'Point of Care', 'Clinical Chemistry' & 'Molecular Diagnostics' markets going forward.
First a bit of background and how Quidel came to acquire Ortho Clinical Diagnostics in December of 2021. Quidel in 2020 ramped up the manufacturing of its COVID tests in 2020 due to significant demand as a result of the COVID pandemic. In early 2021, Quidel received emergency use authorization for its at-home Covid test technology. Quidel's sales as a result grew at a breathtaking speed although implied volatility (risk or future expected move) increased significantly to the upside.
Ortho also took advantage of the 'new normal' in 2020 & 2021 launching multiple antibody & antigen tests to satisfy demand in the market. Suffice it to say, innovation was key in both companies, and now that they have essentially merged the new 'entity' is a core diagnostics play where the COVID testing franchise contributes to all three of the segments mentioned above (Clinical Chemistry, Molecular Diagnostics & Point Of care)
However, as we see from the stock's technical chart, lower lows continued in QDEL after our commentary (resulting in $2+ billion having been wiped off the company's market cap) with shares now coming up against long-term support. In fact, given the height of the long-term depicted triangle, one may believe that shares must remain above their 2022 lows to avoid a sustained trend of lower prices here. Unfortunately, QDEL continues to experience growth problems on the top line and further down the income statement. Suffice it to say, despite the near-term potential in QDEL's Vitros system, the Sofia platform as well and the Savanna System, the market is clearly waiting for these growth catalysts to start producing results in the company's financials. To this effect, QDEL remains a HOLD for us until we see a change in sentiment surrounding this play. Therefore let's delve into the company's recent quarterly report and illustrate what must change internally for the market to price shares higher here over time.
QDEL Intermediate Technicals (Stockcharts.com)
Cash-Flow Headwinds Point To Not Enough 'Value'
Management estimated early last year that the company would generate $700 million in operating cash flow in fiscal 2023. However, with a negative operating cash-flow print of $30.6 million in Q2, and negative GAAP earnings also projected for Q3, it seems unlikely that QDEL will get anywhere close to this estimate. Generating sizable amounts of cash flow is always a priority for companies but even more so for a company such as QuidelOrtho. The reason is that the company's cash balance was drained by some $175+ million in Q2 as CapEx spending ($42 million) & debt repayments ($71 million) took their toll on the finances.
Suffice it to say, that all eyes now point to Q4 which is traditionally along with Q1 the strongest 3-month period for the company. As we see below, earnings revisions have stabilized over the past thirty days for Q4 although the present estimate is still down over 6% over the past three months alone.
QDEL Consensus EPS Revision Trend (Seeking Alpha)
Although long-term debt dropped to almost $2.3 billion at the end of Q2, interest expense rose in the quarter. The risk here (from a long-term investor's standpoint) is that if growth concerns persist, QDEL's sizable goodwill ($2.47 billion) balance along with intangible assets ($3+ billion) would eventually need to be whittled down in value in order to account the 'new normal' QDEL finds itself in. Case in point: elevated growth rates need to return swiftly.
QDEL's cash-flow trends point to why we believe this stock is a 'Hold' at present. From a valuation standpoint, the company's forward GAAP earnings multiple comes in at 53.27 which is well ahead of what this sector's earnings trade at (25.61). In fact, we would need to see the stock's 2023 highs of approximately $94 a share to be taken out (thus reversing the bearish intermediate technical trend) in order to become interested on the long side here once more.
COVID Related Revenues Continue To Disappoint
The merger of the two companies and QuidelOrtho's investments to date clearly demonstrates management's long-term view. QDEL's labs business unit and triage performed very well in the second quarter where the former's supply-chain issues are expected to abate somewhat for the remainder of the fiscal year. In fact, given how little QDEL's COVID-related business makes up of the company's top-line sales number, one may be forgiven for believing that the market will soon dismiss this side of the business. Updated guidance for COVID revenue in the respiratory segment comes in at approximately $350 million. This means, its projection only makes up approximately 11%+ of QDEL's full-year top-line sales projection
Not so fast. That $350 million in top-line expected COVID-related sales is more valuable than QDEL's sales on average due to higher margins. In fact, the lower, COVID-related sales fall this year, the lower QDEL's margins will fall as a result. In fact, the CFO guided lower gross margins for fiscal 2023 (low to mid 50's) on the recent Q2 earnings call as a result of the significant fall in the company's respiratory segment this year. Therefore, we need some stability with respect to expectations on the respiratory side of the business or we need extra growth on the non-respiratory to compensate. The recent US government decision to provide free COVID tests will increase demand so it will be interesting to see how far this trend goes.
Conclusion
Therefore to sum up, what investors need to consider here is that the market takes into account everything associated with a respective investment. QuidelOrtho may be setting itself up for strong growth in upcoming years but the market as of yet refuses to price this expected growth into the share-price. We believe this is due to a leveraged balance sheet and poor cash-flow generation numbers in recent times to name but a few reasons. Let's see what Q3 brings. We look forward to continued coverage.
For further details see:
QuidelOrtho: Growth Problems Persist Due To Pandemic Wind Down