As the market continues to digest a concrete set of macro variables, unprofitable medical technology remains out of fashion, according to estimates. Our US equity strategy seeks to position itself against long-term cash compounds that exhibit strengths in both incomes [realized and expected] and return on investment [ongoing and trailing]. After careful review, I have determined that InfuSystem Holdings, Inc (NYSE: INFU) displays a weak affinity with the type of stock premiums described above. With shrinking return on investment and earnings trends, there is a lack of flesh to put on the skeleton in the investment debate here. Net-net I priced INFU as a hold with a price target of $4.40.
To note: Before reading on, remember that there are inherent risks associated with investing in small cap stocks. Our thesis is ‘neutral’, which means that it is suspicious of both upside and downside risk. Price action can be disconnected from fundamentals and volatility can be higher than in more established markets. While INFU’s long corporate history and extensive client networks somewhat offset this, these remain key risks to the investment thesis that must be considered.
INFU Revenue Stack – Second Quarter Figures Give Unique Insights for FY22
INFU came in with a relatively weak set of numbers last quarter that missed consensus estimates both up and down. Net revenue of $27 million (“mm”) increased 900 basis points year-on-year and was a quarterly record for the company. Segmentally, the bulk of the upside was recognized in the biomedical services sector, stalling a roughly 36% year-on-year gain to $11.5 million. Revenues from this segment were accounted for under a new master services agreement that commenced in April. INFU estimates an annual revenue contribution of $10-12 million from this contract “after an initial ramp-up period of approximately 15 months” by the 10-Q.
Meanwhile, due to the agreement mentioned above, the entry costs were higher for the second quarter and therefore the revenue cost and gross profit were respectively higher and lower by one year. year to year. Gross margin decreased by approximately 500 basis points year-on-year to $14.9 million, or 55% of revenue. Moving down P&L, and OPEX increased by approximately 235 basis points from Q2 FY21, resulting in a net loss of $164 million or $0.01 loss per share, down substantially from the year with earnings of $820 million or $0.04/share.
In order to better understand what exactly we buy in INFU, I went ahead and separated the numbers into a stack of income and investments. With respect to the former, revenue and earnings trends have stabilized to be on a sequential basis since FY20, as shown in Table 1. As realized FCF returns began to climb from the lows in FY19, these trends have reversed since the fourth quarter of FY21. and are drifting lower.
Meanwhile, cash flow from operations has remained erratic in recent quarters, but shows no signs of growth. Therefore, profit-based valuation measures [P/E, PEG, earnings yield, etc] have less liquidity to support the valuation itself. To illustrate, as shown in Chart 2, the net income to cash flow ratio has tightened significantly on a quarterly basis since the middle of FY21′. Meanwhile, Exhibit 3 illustrates INFU’s free cash flow bridge between revenue and net income for the second quarter of FY22.
Exhibit 1. Quarterly cash flow and revenue have stabilized since FY20, producing lumpy FCF and realized FCF returns.
Exhibit 2. With less CFFO support income [and P/E, earnings yield, etc.] This must be taken into account in the investment debate.
- The reduction in CFFO and earnings are not attractive features in the current climate.
- This is coupled by a yield crunch FCF.
Exhibit 3. INFU FCF Bridge for the second quarter shows low FCF conversion from revenue to CFFO.
INFU investment stack – tightening trends
As shown in Table 4, quarterly Return on Invested Capital (“ROIC”) trends have tightened since FY2019. of INFU has seen a sequential decline since FY15. It printed an ROI of around 30 basis points last quarter, compared to 7% this time around in FY20. At the same time, the company’s capital intensity has increased via the degree of invested capital achieved each quarter since FY18.
These are unfavorable trends in my view. Our US equity strategy prioritizes long-term cash compounds that generate substantial FCF below net income. INFU misses this target due to its capital budgeting decisions. Ideally, we would either see a high degree of ROI, or at least the number would increase by a few points each period. Without the tangible cash flows to piggyback on the investment debate, this is a bearish tilt in the risk/reward calculus.
Thus, INFU’s continued investment and capital budgeting trends are not attractive to our current strategy. What about its already existing investments/assets? As shown in Appendix 5, the company’s return on average assets (“ROA”) and asset turnover have each declined after peaking in fiscal 2020. While TTM asset turnover is strong at $1.10 for every $1 in the asset base, the performance of those previous investments/assets fell into the red. Alas, these results illustrate that INFU’s continued investment performance and current asset base suggest that a valuation risk adjustment should be made.
Exhibit 5. Contrary to INFU’s ongoing investment habits, the company’s return on past investments/assets has also declined, accompanied by reasonable asset turnover.
Evaluation and conclusion
The shares are trading at a discount to the GICS industry peers used in this analysis, as shown in Appendix 6. However, on a TTM basis [not shown], the stock is trading at a substantial P/E of around 117x. Additionally, trading at ~3x book value and ~1.5x sales represents decent value compared to the peer group shown below.
Table 6. Analysis of multiples and comparisons
Consensus has INFU to print EPS of $0.06 in FY22 and $0.20 in FY23 and I’m happy with that number as it lines up with our own internal calculations for the stock going forward. At 22x that estimate of $0.06, that sets a price target of $1.33, well below the current market price. At 22 times FY23 estimates, we are at $4.40. In every sense, INFU looks overvalued given the earnings and ROIC trends outlined above. With a lack of flesh to put on the skeleton from all angles, I re-evaluated INFU with a price target of $4.40.