This week: ASX v Wall Street
FYTD: ASX v Wall Street
Note: not all clients will hold all of the securities we discuss.
In an effort to provide a more complete picture, we will continue to provide some updates on the prospects of our portfolio companies as gleaned from our coverage of the ASX Reporting Season:
- Nanosonics (NAN)
- Paragon Care (PGC)
- Imdex (IMD)
- Garda Property Group (GDF)
Nanosonics Limited (NAN FY23 result)
Nanosonics Limited (Nanosonics) develops, manufactures, and markets equipment for the high-level disinfection of ultrasound probes and other pieces of medical device hardware. Its lead product, the Trophon, for disinfecting obstetrics/gynaecologic probes, is now available in most major markets.
Nanosonics plans to launch a new platform (CORIS) for endoscope reprocessing in the coming 24 months. This will be critical for future company growth.
The company released its full-year 2023 results on the 2nd of August. The revenue reporting aligned with our expectations (up 30% year-on-year, excluding current effects), and profitability exceeded expectations, especially excluding the costs associated with the new Coris product.
The delay in CORIS commercialisation was the biggest disappointment of the result. Although necessitated by US approvals process changes, it impacts the global rollout. US commercialisation will likely be delayed by 6 months, EU/AUS commercialisation is likely pushed >12 months (previously expected to launch late CY23/early CY24).
By the end of August, the share price had fallen 11% despite the solid operating metrics due to the delay in the Coris product. The revenue and long-run value impact of the delay is minor, and we are choosing to take advantage of the short-term thinking of the market and add to the position.
The original product, the Trophon, goes from strength to strength, and as a reminder, has 3 critical components for long-run value to shareholders.
- A Trophon is increasingly a required piece of equipment that accompanies ultrasound devices, playing a mission-critical part of the workflow. Higher usage leads to increased sales of new Trophon units.
- The Trophon sales employ a “razor / razor blade” revenue model. First the Trophon is purchased and then to use it requires the purchase of consumables from Nanosonics (no other options). The higher the installed base and the more the equipment is used, the more the high profit consumables are sold. In FY23, consumables revenue is TWICE the level of equipment sales revenue.
- When new designs of the Trophon are developed (version 2.0 is in the field now), the older versions are upgraded, at a similar price as the original. Across a 10-15 year period the same client may purchase three units.
The upgrade cycle and the growth of the installed base can be seen in Figure 1 below.
Figure 1: Installed Base of Trophon Units leads to Upgrade Demand
The growth of consumables revenue at a faster $ rate than the growth of device sales is clear in the Figure 2 below.
Figure 2: Consumables revenue grows more $ of revenue than device sales
The combination of these three revenue streams, new devices, upgrades and consumables, and the development of the new CORIS device provides significant value.
The share price is currently 67x FY23 earnings per share, making Nanosonics amongst the most expensive stocks in the portfolio. However, this figure doesn’t tell the entire story, as current earnings include substantial investments in the new product. In Nanosonics results presentations, the company has assisted the market in understanding the underlying profitability of the Trophon device itself. The results are impressive, with after-tax earnings of $32.5m.
This places Nanosonics on an earnings multiple of approximately 40x, even if we assume that the CORIS product failed. Such an earnings multiple compares more than favourably against companies such as Cochlear and Fisher & Paykel Healthcare, which trade at 58x and 47x, respectively.
What the market said:
“The delay in CORIS commercialisation is clearly the biggest disappointment of
the result. Whilst in a revenue sense a ~6-month delay in US commercialisation does not have
material impacts on NAN in the forecast period, the greater valuation detriment comes from the
ongoing dismay from investors who have long awaited CORIS commercialisation.” (Wilsons)
Imdex (IMD FY23 result)
Imdex is a relatively new portfolio position and has admittedly had a tough initiation, from a share price perspective, since we began to purchase the stock.
Imdex, a leading mining technology company, provides a number of sensors and drilling tools used by mining companies to generate more accurate drilling results and ore body estimation. It is a No 1 or 2 player in each of its key products. The recent acquisition of its largest competitor, Norwegian-headquartered Devico, has allowed the company to round out its geographic footprint and key mining company relationships more broadly into Europe and South America.
Figures 3 and 4 : Financial and strategic progress made in FY23
Softer 2H results reflected the mining capital-raising and exploration cycle being more recently challenging. Most notably, this has been the case in the Australian and Canadian markets. Rising funding costs and rising wages have been a driver for smaller gold companies to pull back from the market. Accordingly, the IMD stock price has been soft in the past 6 months. But as figures 5 & 6 below demonstrate, this cycle appears to have bottomed.
Figures 5 and 6: Junior Miner Equity raisings have troughed, which means drilling activity should lift
What the market said:
“We upgrade Imdex to Buy, as we believe the stock offers leverage to the upcoming inflection point we are seeing in global mineral exploration activity. We view Imdex as a quality cyclical ASX Small Cap, with its market leading exploration Sensors IP, proven track record of above mkt growth, strong balance sheet (FY23 leverage 0.5x) and exposure to an attractive LT thematic in demand for critical metals (i.e. copper/lithium). Imdex shares have de-rated and fallen significantly YTD, down c.40%. The stock is now trading at 13x 1yr fwd P/E, representing the low end of its long-term 1yr fwd P/E range (13x-30x). This weakness has been driven by the gradual decline in exploration drilling activity through CY23 ytd. Our analysis has found that we now nearing an inflection point, with key leading indicators such as Junior miner equity raisings and active drill holes both showing c.4-5mths of consistent sequential improvements.” (UBS)
Paragon Care (PGC FY23 result)
Paragon is a longstanding company in client portfolios. The business is both a
- Manufacturer of immunohaemotology/blood products (Immulab), which was a business purchased from CSL (another FS portfolio holding); and also a
- Wholesaler of medical equipment (Critical Care, Eye Care, Neonatal, Surgical, Diagnostic and Scientific Equipment) within Australia and several markets in Asia.
The story has not been a popular one with investors. This is because it is a conglomerate of sorts, and has a history of acquisitions that make understanding the operational performance of the business a little difficult.
We met with the CEO (Mark Hooper) and CFO (Josephine De Martino) at our offices this week. The executive team recognises the challenging task they have to improve return disciplines within the business and to create a coherent, more focused strategy. This is a task which will take time (Mark only joined in middle 2022), but for which the outlook beyond FY24 appears increasingly optimistic
Figure 7: Growth has been assisted by acquisitions
Source: Company reports
As the Underlying EBITDA is tracking at ~$38m in FY23, the management’s public target for EBITDA of $100m in FY27 will require excellent execution to achieve.
At the current share price the market assumes both
- The existing business will fail to generate the earnings it has been able to achieve in the past; and
- The plans for future growth are not successful.
Given the health industry dynamics the business operates within, the diverse reach Paragon has across Asia, and the range of intellectual property it is seeking to exploit, the company should trade at much higher prices.
What the market said:
“Bigger picture, PGC maintains its objective of building a $100m EBITDA business by 2027, with half of this growth targeted to come from organic initiatives and the balance from more targeted M&A. We note greater clarity is emerging on this front, with considerable work having been made over the last 12 months to build a comprehensive strategic work having been made over the last 12 months to build a comprehensive strategic plan….While the company hasn’t provided guidance, they anticipate further organic growth in FY24, with growth accelerating in FY25. Moreover, given a number of key growth initiatives don’t come into play until late FY24” (Euroz).
Garda Property Group (GDF FY23 result)
Garda Diversified reported its full-year 2023 results in late July. Most companies in the Australian listed property space do not overly enamour us. We believe that many have been slow to write down the value of their holdings, many are also failing to come to terms with the leverage on their balance sheets, and others are too expensive for the cash flows they create.
In response, the Property sub-portfolio is carrying a large amount of cash and has investments in property income funds (such as Merricks Capital) and private industrial properties (Harrick Rd) instead. In the listed space, we have positions in investment companies such as 360 Capital (TGP) and in Lend Lease (LLC), the global developer, owner and manager likely to be restructured in coming years.
Amongst the few property trusts we own, Garda stands out. We are attracted to Garda for three key reasons:
- Quality of assets they own: Garda has a happy knack for purchasing assets that retain significant optionality; that is, they have more than one possible path to value creation
- Development potential that extends many years
- A nimble management team that takes a view of the market cycle and is happy to buy & sell assets when the time is right
In the 3 years to the end of FY23, Garda was the 5th best-performing property trust (out of 46) on the Australian market. The best was Home Consortium, another portfolio holding.
Garda has reported a net tangible asset position of $1.96 at year-end versus a trading price of $1.24 today. The gap between reported values and the amount the ASX market is willing to pay indicates to a significant way, the degree to which valuers are caught short and still need to reduce their values. The key for investors is what the impact of the difference is on the behaviour of the companies. Many larger property trusts, especially those holding expensive Sydney office buildings, are neither trading nor reducing the values.
One of the key features of Garda is the desire to trade. In 2023, the asset recycling program saw $75 million of capital released and allocated to the industrial pipeline. A property in Mackay and Box Hill was sold.
- Garda acquired Mackay in 2016 for $29.5 million and sold it in December 2022 for $35.5 million.
- Box Hill was valued at $18.5 million on a 9.0% capitalisation rate at IPO in 2015. The asset was sold in April 2023 for $40.3 million. This was a great result in cash terms but was a discount to the previous book value of 14%.
The sale of additional parts of the Botanica investment in Richmond VIC would provide additional flexibility and further reduce the exposure to office buildings. We believe that high-quality suburban offices such as Botanica should trade at a capitalisation premium (rather than a discount) to the already overpriced rents per sqm terms currently sought but rarely achieved by CBD buildings.
The company has an extensive pipeline of industrial development to complete in the next 2 years, predominantly in Brisbane, where industrial rents are growing strongly.
The increased value of these sites as they are developed leads to a further concentration of asset mix in industrial assets. The likely path is shown in Figure # below. Post-development, the company will still retain 19 per cent of its assets in land and development, providing additional value creation for years to come.
Figure 8: Asset recycling and industrial development pipeline will drive value creation and mix improvements.
Distributions for FY24 have been reduced to 6.3cps; This payout represents a healthy 5%+ dividend yield, which is attractive when the business fundamentals will also be improving.