2023-08-07 09:06:44 ET
Summary
- Rockwell Medical stock has seen a massive year-to-date rally, breaking quarterly revenue records and regaining its competitive advantage.
- The company has significant international expansion potential and is positioned to benefit from positive secular trends in the healthcare industry.
- The stock is undervalued and presents an attractive opportunity for investors looking to diversify their portfolios with a micro-cap stock.
Investment thesis
Rockwell Medical ( RMTI ) stock is on fire this year with a massive year-to-date rally. The momentum is strong; the company broke the quarterly revenue record in Q1 and has regained its massive competitive advantage due to the reacquisition of distribution rights for its primary product. That is the big catalyst for profitability metrics expansion due to gaining much stronger pricing power. The company is also likely to absorb positive secular trends in the upcoming years and has significant international expansion potential. All in all, I consider the stock a "Buy" for investors willing to diversify their portfolios with an interesting micro-cap opportunity.
Company information
Rockwell Medical is a healthcare company that develops, manufactures, commercializes, and distributes a portfolio of hemodialysis products for dialysis providers worldwide. RMTI is the second-largest supplier of acid and bicarbonate concentrates for dialysis patients in the U.S.
The company's fiscal year ends on December 31. According to the latest 10-K report , dialysate concentrates accounted for approximately 98.4% of RMTI's revenue in FY 2022.
Financials
RMTI's financial performance demonstrated a steady improvement over the past decade. Revenue compounded at a 3.7% CAGR and the operating profitability metrics improved notably over the past ten years. The company's free cash flow [FCF] margin ex-stock-based compensation [ex-SBC] has also improved notably, though it was still negative in FY 2022.
Although a sustainable positive FCF margin was not achieved yet, the company's balance sheet is sound. The leverage ratio might seem high, but still, RMTI is in a net cash position. It is also important to underline that a small part of the debt is short-term, below $1 million. Liquidity ratios are solid as well, far above 1.
Seeking Alpha
The latest quarterly earnings were released on May 15, when the company topped consensus estimates. The management was happy to announce that in Q1, RMTI achieved its highest quarterly revenue in history. Overall, revenue demonstrated strong growth momentum with a 22% YoY growth. The gross profit increased more than three times from $800 thousand to $2.6 million, which is impressive. During the earnings call , the management reiterated its confidence in strong financial performance in the near term and projected full-year revenue at $80 million at the midpoint, meaning that YoY growth is projected at 10%.
The upcoming quarter's earnings will be announced on August 14, pre-market. Quarterly revenue is expected by consensus at $18 million, which would be slightly lower YoY. What is positive and very important is that the non-GAAP EPS is projected to improve significantly, from $-0.56 to -$0.12, meaning the company is heading closer to breaking even.
I think the company operates in an industry that will likely benefit from secular tailwinds in the foreseeable future. First, according to the latest 10-K report, RMTI commissioned independent research from L.E.K. Consulting, revealing that the hemodialysis concentrates market in the U.S. alone is anticipated to grow to approximately $500 million by 2026 or at a 9.6% CAGR. Second, hemodialysis as a disease is still a big problem for humanity, and the global kidney dialysis market is projected to grow at a 6% CAGR over the next decade. RMTI being the second largest supplier of acid and bicarbonate concentrates for dialysis patients in the country means that it has sufficient manufacturing scalability and infrastructure to absorb secular tailwinds. It is also crucial to emphasize that in November 2022 , Rockwell reacquired its distribution rights to its hemodialysis concentrates products from Baxter and agreed to terminate the exclusive distribution agreement. That said, RMTI can now independently price its products, eliminate costs associated with manufacturing covenants, improve manufacturing efficiencies, and realize the full benefits from those improvements. While it is difficult to quantify this effect on earnings reliably, it immensely improves the company's competitive advantage in the market.
It is also important to mention that RMTI's international business represents only 10% of the total, meaning the company has notable upside potential for revenue growth driven by international expansion.
Valuation
The stock soared more than 200% year-to-date, significantly outperforming the stock market and the Healthcare sector ( XLV ). Seeking Alpha Quant assigned the stock a decent "B" valuation grade, though a significant part of multiples is inapplicable due to negative profitability metrics.
RMTI is a growth company. Therefore, I proceed with my valuation analysis with the discounted cash flow [DCF] approach. I use a 10% WACC discount rate from RMTI's future cash flows. I have revenue consensus estimates for the two upcoming years, estimating slightly below 20% annual growth in FY 2023-2024. The FCF margin is challenging to forecast for companies that are relatively far from turning profitable. To be conservative, I expect the FCF margin to turn positive in FY 2026 and expand by one percentage point yearly. I want to underline that my base case scenario's assumptions are very conservative overall.
The stock is still about 40% undervalued under conservative assumptions. To be fair, both with bears and bulls, I want to simulate the second scenario with more optimistic revenue growth prospects. I implement an 8% long-term revenue CAGR for the years beyond FY 2024. Other assumptions will remain unchanged.
As you see, the revenue growth pace matters a lot. With a more optimistic yet cautious growth trajectory, RMTI now looks about 73% undervalued. Considering the company's sound balance sheet, the stock looks very attractively valued.
Risks to consider
While Rockwell is the second-largest supplier in its niche, it is crucial to mention that the number one player in the industry is a giant compared to RMTI. As it is stated in the company's latest annual SEC filing, Fresenius Medical Care ( FMS ) is the principal competitor holding a staggering 37% market share of the in-center hemodialysis patients in the U.S. Indeed, the comparison looks like David versus Goliath story looking at the scale of Fresenius. FMS is a global healthcare company with a $15 billion market cap, which generated over $1 billion in FCF during FY 2022. RMTI's major competitor has an unmatched scale and more resources to innovate and develop new solutions. I consider the competition risk as the biggest for Rockwell.
As a healthcare company, Rockwell faces significant regulatory risks. The FDA or comparable foreign regulatory bodies' regulatory approval processes are resource-consuming and unpredictable. The inability to obtain necessary approvals for the company's drug pipeline is highly likely to cause disappointment for investors, which will result in a stock sell-off. That said, investors should be ready to tolerate massive volatility and hold the stock long-term.
Bottom line
To sum up, I consider Rockwell as a "Buy" for long-term investors seeking exposure to microcap stocks. The competition risk is massive, but the upside potential outweighs it in my opinion. Regaining exclusive distribution rights from Baxter is a big long-term catalyst, and the company is now able to exercise much bigger pricing power, which is already expanding profitability metrics. Last but not least, industry tailwinds are also highly likely to help RMTI to grow.
For further details see:
Rockwell Medical: Upside Potential Outweighs Competition Risk