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I've already shared some analysis on the $PNV financial results in earlier Straws, which I do not repeat here. However, I commented earlier this week that David, Swami and Jan provided a lot of detail both in their voiceover on the presentation and also in the Q&A.
So, I thought I'd share the key nuggets I extracted from going back over the call and the transcript. In total, I think it provides a much richer picture of the strength of this business, and underscores my bullishness on it as a long term growth stock.
I'll bear all this in mind when I do my major valuation update at FY. There is a lot to consider.
So here goes.
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My Overall Key Takeaway: Sustained, capital efficient, long-term growth, driven by existing and new markets, existing and new indications, and potential new platforms. $PNV is now profitable and cash generative.
Key messages
- Strategy and capital allocation - long term growth
- Financials - outperformed their internal budgets and plans
- Capex - material step up in FY25 to build "Mega" for $25m, but fully budgeted in 2022 capital raise
- Markets - now serving 37 markets with increasingly material RoW growing strongly
- Organisation - now built out, so future growth in headcount slowing
- Clinical development - clinicians leading broad expansion of indications; potential for multiple new platforms
1. Strategy and Capital Allocation
DW made clear the strategy is to keep expanding “both in indications and in geographies” wherever they can see the margins. He said this in clarifying feedback he has received on his statement that he doesn’t care about profits. The clarification is that by focusing on growth where he can see margins, then profits will follow. He tweaked his rhetoric by saying, “if you want dividends, you’ll need to sell some shares.”
2. Financials
All details covered in previous straws, but CFO Jan made the comment that they have achieved profitability earlier than budgeted because sales have been above plan
For example, the $8m month in November wasn’t budgeted until April
On cashflow, the business is essentially cashflow breakeven.
DW discussed reporting. He said there has been feedback on their approach of reporting "record sales months". He's discussed it with the Board, and they've decided to continue because they want to keep investors informed as key milestones are achieved.
3. Capex
On the new facilities, the main investment is yet to come
1H24 Capex of $1,1m was design work for facilities plus some R&D equipment
2H Capex “marginal increase in capex as the design process nears completion and we expect to commence construction in 1Q FY25.”
Total planned capex for the third “Mega” production line is $25m over two-year period
Guidance on the spend profile will be given once design is completed (FT24?)
Until new facilities are ready there are no issues with current manufacturing output form the existing two lines, which see continuous improvements in output and efficiency, evidence by the very low % Gross Margin.
Mega will be designed to be modular and scalable, as they plan to have to accommodate many more SKUs than at present.
(My note: Key risk to monitor: will procurement and construction costs increase materially since project first announced in end-22 when the design is complete and contracts let in FY25? A 25-50% cost blowout would not be unprecedented. While that would not be good, it is not really that material, overall.)
4. Revenue & Markets
RoW sales are becoming material "from 16% of total sales to 24%"
Now have sold product into 37 countries
Key market details (not all presented but covered in voice-over):
After not having raised prices in US for several years, there is now an agreed approach for price revisions
In the US, “narrowing the gap” to the market leader in the “difficult burns” category
BARDA trial now 91 patients enrolled; 1st patient enrolled in India (2 centres approved). Looking at options with FDA and BARDA. Base option is to get to 120. Enrolment expected to be complete by May. There will be announcement when it is decided how to close out the trial to a meaningful close. Also working with another FDA agency to see how “real world” data can be sed to give added claims into the trial.
Strong growth in ANZ where already #1 in burns is largely outside of burns
India – “half a dozen tenders” under way. “Getting good soundings.” “Very optimistic that in the very near term we’ll have something to say.”
HK also continues to “trade well”. China – pathway identified, but not yet going beyond HK. Developing plans for extending into Shenzen area (GBA).
Germany: market leader in “Advanced Dermal Substitutes” (4th largest market after US/UK/ANZ – note: Ger. is a distributor market)
Turkey – large initial sales
Middle East – sales driven by a physician who relocated to ME from East Coast US and wanted the product
Japan – have a partner defined and a lead KOL. Working to see if data already submitted to US FDA can be used for submission in Japan with MoH, KOLs and reimbursement agencies.
New demand arising from war zones in Ukraine ($1.2m sale in February - not 1H; “we believe another coming”) and Israel. They believe they are getting some sales orders from other countries that are ending up in these locations, as well as charities.
Several ongoing discussions with charities, UN agencies, Gates Foundation, WHO, MSF, etc. to help get the product to countries that otherwise can’t afford it.
5. Organisation
Headcount +64 on PCP, but only +19 in 1H FY24
Plan for 2H FY24 from 237 to 260 +(23-25)
- US sales: currently 75 (65 reps + 10 managers) going up to 85
- ANZ sales
- R&D and Manufacturing
- Back Office: now have the full teams and scalability
Completing the build-out of the senior management team
- HR lead has started in last few weeks
- Chief Medical Officer joining – leading on FDA and BARDA conversations
- General Counsel about to be appointed
- Close to appointing APAC lead, for entry to China and Japan, and other countries
6. Clinical Developments
My key takeaway: It is clear here is the potential for many years of development leading to new platforms and multiple groups of new indications. Most of this is clinican led.
A key observation is just how important the customer-led (clinicians) work is. (My Note: Just reflect on the following points and consider the tiny R&D budget. I don’t think I’ve ever seen this before in healthcare. There is so much upside to come.)
DFU study: stopped after 25 patients because not getting right wound debridement. Protocol to be re-written and brought back in-hospital (rather than outpatients) to get great consistency needed for a successful trial. Expecting to focus more on to limb salvage – new trial, Announcement on trials coming in a few weeks
Prof Marcus Wagstaff trained 30 surgeons in UK who then took the knowledge onwards to Ukraine
Much clinician-led development taking place into new indications; 230+ publications (214 at FY23), “literally across the entire clinical spectrum”
Customers proposing BTM could be a replacement for allografts (papers on this). Potential to upshift and replace grafts
Several authors proposing that BTM could be a good solution in low and middle income countries where other technologies are constrained
Overall global markets outside US and W. Europe and a few market in APAC “on the fringes” (hey! Swami, that’s no way to talk about ANZ) – we are focused on sustainable, global growth
MTX rolling out in US – demonstrating great outcomes in open abdominal and dehisced wounds. Will start compiling evidence to allow MTX to be rolled out globally. Focus has been using MTX with “expert clinicians” on complex applications, and expecting wider roll-out from July.
Working to be differentiated in connecting KOLs across the world who can teach other surgeons in how to treat acute complex wounds.
$PNV already recognised in burns and trauma, and now looking to go beyond these into:
- Oncological resections of head, neck, scalp, skin and oral cancer
- Potential to use in infections (necrotizing fasciitis and hidradentis) where competitor products cannot deliver
- Getting into complex vascular space to save limbs from being amputated
Developing an implantable platform in hernia and breast. Still not happy to share timelines, but happy with the feedback getting from clinicians. Addressing how to build a “sustainable platform in the implantable space”. (Sounds like still some time off, but I still think this is OK given the growth potential of BTM and MTX)
Working on developing Novosorb Mesh product, currently bench testing, testing with animals, and sharing it with clinicians to establish their expectations on added strength and flexibility. Work is being done to compare with the market leader.
Disc: Held in RL and SM
Three updates this morning - seems about right.
Superbull Macquarie slowly coming into line!
While I am not running my model update until FY, I'll tweak my val. up by 5% just so as not to be too out of whack with the new information.
Disc: Held in RL and SM
Why I Wish He Wouldn't
I couldn't help myself write this straw on why I wish David Williams would change his investor relations behaviour. The commentators I have seen since yesterday's trading update announcement have made three statements about yesterday's release:
- Why report two months sales data compared to pcp, when the quarter end is a few days away? (There wasn't even an $8m month to at least be consistent with previous patterns of reporting) Particularly when there isn't really anthing to disclose.
- The growth results are strong, fair enough. (Particularly given the languishing SP)
- It doesn't change views on valuation
That's pretty much where I was yesterday in my straw.
But, you say, the market has moved up 14% in the two days. True, but the stock is still down 50% from its current 12m high in February.
So here is why I don't like David's "cherry picking reporting" and it needs a graph to explain. Note that the numbers below are made up, as they seek to illustrate a general point that is applicable to $PNV. The calculated rates of growth are relevant, however.
So here's what it shows. (Don't worry about the absolute numbers, I just picked 100 as an arbitrary starting point!)
Blue Line (acutally a curve), starting at June-22 at 100, this line grows each month at a compound monthly rate of 3.99% or 60% p.a. - which is in the ballpark of $PNVs current annual sales growth.
Orange line: Jul-22 and Aug-22 are depressed below the trend by 20% - indicative of the lumpiness we know exists month to month in $PNV sales. Let's assume we had two bad months at the beginning and two strong months at the end. The "lost" sales from the beginnining are added back in above trend in Jul-23 and Aug-23. So the total sales over the 14 month period is the same for the Blue curve and the Orange curve. It's just that the blue curve is perfectly smooth and on trend while the orange curve is lumpy at each end.
This is my suspicion of what could be going on. Two soft months cherry-picked at the start and cycling two strong months at the end for pcp comparison.
Red Line: So, let's do the maths. What's the ANNUAL SALES GROWTH rate from Aug-22 to Aug-23 (or Jul-22 to Jul-23)?
Blue Line = 60% growth. Red line (for orange curve) = +125%. Over double the underlying growth rate.
That's how misleading annual growth numbers can be if you cherry pick your data-set.
Which is why the high reported numbers in yesterday's ASX release from a management team with a reputation for cherry-picking data shouldn't necessarily result in any change in our view of the underlying value of the business.
Of course, the good news is that, even if the release represents "peak cherry picking", its does mean that underlying revenue growth is still in the region of 50-70%, whereas the market is expecting +42% this year and +34% in FY25.
As a result, no analyst upgrades should be expected, apart from the bears who have a SP <$1.50 or so. (There is one in my dataset with a price target of $1.08. Maybe they'll wake up one day).
Life would be much easier if we got any of the following:
a) Monthly sales, every month or
b) Quarterly sales, every quarter or
c) HY and FY results. Period.
Of course, I could be wrong, and perhaps the underlying trend is stronger. I hope it is. But that's the problem with management who are too promotional and inconsistent in how they report. You just can't tell.
If I wasn't so high conviction on the product and the business, I think I would have given up long ago due to exhaustion.
No doubt, the David Williams Circus will continue to roll on. So,... roll up, roll up.
Disc: Held
I have finally rebuilt my valuation of $PNV. The reason for the challenge in doing it, is that the change in sales & marketing strategy since Swami came onboard as CEO. This has driven the need to create an entirely different way at looking at both sales growth and contribution margin - the dual push on developed and developing markets means that modelling performance by averaging key metrics means you lose sight of what is going on. So the model needed a total rebuild.
Estimated Value $2.00 Range [$1.63 - $3.30]
Based on 9 scenarios, I arrive at an expected value/share of $2.00, and an estimated p10%-p90% range around this of [$1.62 – $3.30].
This is a significant downgrade from my prior valuation $2.46 [$1.63 - $3.28] from September 2022. However, what is interesting is that the upside and downside ranges are largely unchanged (albeit also reduced about 10% given the passing of a year.)
Revenue Growth
Revenue growth is modelled driven by sales force expansions aggregated into separate Developed Markets and Developing Markets buckets.
- Developed market performance starts with average sales per rep of $0.811m p.a.
- In Developing markets, realised prices are modelled at 25%, 30% and 35% of developed market prices (see “Commentary” at end of this Straw). At this stage we don’t really know what the net sales values will be in these markets.
- Costs and Revenues are subject to constant annual inflation (2.5% developed markets and 5.0% in developing markets.)
- Like-for-Like growth: As more and more indications for Novosorb become accepted and applied, the value of each account is expected to increase, and each saleperson become more productive by accessing more clinician-customers at each hospital visit. Research publications indicate that we are still very early in this process of adoption. On average, an annual “Learning” growth factor is applied to each Sales Rep across a range from a minimum of 3% to as high as 7% across different scenarios. This is one of the most important value drivers. (Hence DW is actually getting investor to focus on the right information in emailing around clinical review studies showing the increasing breadth of clinical applications.) In truth, I have no idea what the appropriate learning rate is. However, as an indication at the expected valuation, a 1% increase in annual learning at the mid-range leads to a $0.30/share increase in valuation. Wow! The best way of tracking this metric is by continuing to focus on the number of sales reps in the USA and the value of US sales. (Swami has said from day 1 that $PNV has to stay close to the physican customers to understand how they are innovating in their use of the product. That's why.)
- Sales and Marketing costs have been estimated by calculating: benchmarks market rates, adding allowances for super, health insurance, seniority mix, incentives and applying a a ratio of one marketing FTE per 7 sales FTEs. A non-FTE sales and marketing expenses factor of 12% revenue has been applied (this covers everything from advertisements, free sales, to conferences and flying opinion leaders around the world.) This is likely to be on the high side, but I have modelled a range of expense growth scenarios to accommodate this uncertainty.
- In developing markets, a 2023 cost for a sales rep. has been estimated at $40k p.a.. This is probably on the high side for current costs in India (as quoted by DW), but over the 10 years the model assumes expansion to all major cities in middle income countries across Asia, Central and South America and the Middle East. The valuation is not hugely sensitive to this assumption.
The output from the Revenue Growth and Sales and Marketing modules is shown in Figure 1 for one scenario, below.
Figure 1: Revenue and Sales and Marketing Headcount for one Scenario
It is worth commenting that I have followed a cautious approach to the build-out of developing markets that may not stand the test of time. For example, in 2023 a team of 22 people has been established in India within months of market entry, with as yet no material sales. By contrast, the combined UKI and ANZ sales teams number only around 13, with combined annual sales of around $7-8m.
As a result, I follow a more cautious build-up in the developing market sales force over time. These reach a total workforce of between 160 to 320 by 2033, with a contribution of 13% of total 2033 revenues in the most conservative to an upper case of 26% in the most aggressive case, with 20% shown in Figure 1 above. This is somewhat at odds with the rhetoric we’ve been hearing from Swami and David over the last 12 months. However, I want to see proof that developing markets can make a meaningful margin contribution before setting too much of my investment thesis against that.
It is getting to grips with the new prominence of India (in particular) and developing markets in general that has given me the most pause for thought in modelling the updated strategy.
In my earlier September 2022 valuation, I assumed a more aggressive approach to Europe and other high value markets like Japan, South Korea, and Taiwan. So, as far as my valuation is concerned, the change of strategy has lopped $0.40-0.50 off my valuation. That is the price of me NOT sharing Swami and David’s conviction. I may well be wrong and will be happy to be so proven!
Cost Growth – R&D and G&A
In all scenarios I assume a moderation in the % rate of cost growth of the company, which over recent years has really been in a start-up mode. David and Swami should demonstrate this disciplined as they are now under pressure to breakeven this year and show a meaningful profit in FY25.
While expenditure on R&D and G&A both grow strongly throughout the 10 years modelled, I assume $PNV remains a highly focused company selling only variants of the Novosorb product (BTM, MTX, etc.). This allows for a highly-focused organisation and cost structure which achieves exceptional net margins.
Figure 2 shows the projected evolution of expenses as a % of Revenue. In Scenario 6 (shown), the 2033 Net Margin is 32%. The range of modelled scenarios yield net margins are 30-36%. This compares with a Net Margin in 2022 for competitor $IART of 12%. Good net margins in medical devices are more typically in the range of 10-20%. So how can this possibly be?
The answer lies in the high gross margin (93% in FY2023 for %PNV). Medical device companies more typically achieve gross margins in the range of 50% to 65%, with $IART achieving 64% in FY22. Thus, $PNV has a very material Gross Margin advantage, providing headroom over the competition of a full 25-30%! That's massive.
This positions it well to respond to competition, as other synthetics will inevitably emerge over time. (To be fair, David has been banging on about this for the 5 years+ I've been following the company, and it was only over the last weeks when I did some detailed industry benchmarking, that I realised how important this is.)
Figure 2: Evolution of Expenses (Scenario 6: $2.16/share)
Looking at the % expense/revenue structure modelled in the above scenario in 2033 and comparing it with $IART in FY22:
- R&D of 8% at $PNV compares with 6% at $IART
- SG&A of 36% at $PNV compares with 40% at $IART (with the latter a much more complex business)
Of course, $IART is a much larger company with a much more diverse product portfolio, so the comparison is limited. However, what $PNV lacks for in economies of scale, it can be argued to recover in its narrow product focus.
(*As a "post-production note": I've probably been a bit aggressive on $PNVs G&A, so will address this next time. In the case illustrated above, if 2033 G&A/Revenue is more like 12%, then value is reduced to $2.04.share)
Total R&D spend over the 10-year modelled period amounts to over $200m (nominal), however, no new products are assumed beyond new variants of Novosorb, such as MTX. It is assumed that significant funds should be spent in supporting studies to broaden the range of product indications, and providing tailor variants, like MTX.
New products for applications in breast, hernia, other internal procedures, and drug elution are all still assumed to be “blue sky” upsides, even though this is where the lion's share of the R&D spend will do. So, there are significant potential upsides for the business that have not been contemplated in these valuations.
This level of R&D investment without an explicit revenue stream justifies the continuing value annual cashflow growth beyond 2033 of 5% p.a. (However, this might be conservative if $PNV is successful in positioning itself in developing markets. Here, although revenues are low by comparison to developed markets, growth rates are very high.)
Gross Margin (GM) Evolution
Historically, $PNV has achieved %GM ranging from 91% to 95%. With the proliferation of product variants and lower price realisations in emerging markets, I assume 93% represents a cap on future gross margins. As the new facilities come onstream in 2025, lifting sales capacity to $500m, I assume %GM falls to 91% as the existing sales bear the fixed costs of the larger production facilities, before returning to higher values as plant utilisation ramps up.
Capex
Capex has two drivers: "base PPE" capex and investment in new production facilities.
Base PPE capex is assumed to grow proportionately with sales.
Expansion of new production facilities occurs in two tranches: $30m capex to scale up to $500m total sales (current reported cost is $25m), and I've assumed a further $40m to scale up to $1000m total sales.
Timing of expansion capex is driven by revenue growth assumptions.
Common Assumptions
WACC = 11%
Inflation = 2.5% (5% in developing markets)
Effective Tax Rate = 30%
Shares On Issue = 1% growth p.a.
Capital Leases grow proportionately with G&A
Working Capital grows proportionately with Revenues
All R&D expensed
Cash Flow Growth in Continuing Value Period = 5% p.a.
Valuation has been performed on a 100% Equity basis - no debt. As the business scales it will make sense to put in some long term debt. $IART by comparison has Net debt/EBITDA of about 2.4x. However, at this stage in its evolution, I prefer to consider the business as 100% equity funded.
Commentary on the Analysis
Developing Markets
With the current push on India and with China to follow the Hong Kong beachhead (3 out of the 4 major hospitals already signed up), $PNV is entering new territory, so all the developing markets analysis is a placeholder. I have, however, tried to err on the side of conservatism. At this stage we have no idea what contribution margins might be achieved.
So let me put this my reservations in context, because I suspect Swami and David would disagree with my analysis. The US medical devices market is c. $164bn p.a., around 3.4% of the US Healthcare Spend. The Indian medical devices market is around $6bn p.a. That’s less than 4% of the US market. In the US, average annual healthcare spend per person is c. $15,000. In India, it is $101.
I understand the clinical and humanitarian imperative to bring lifesaving and life-enhancing treatments to developing markets. And I support it. My point in writing here, is that I can’t at this stage model the economics for $PNV in developing markets with any confidence. The strategic shift in the priority of market rollout has chopped about $0.50 off my expected valuation. Only time will tell it that’s reasonable.
US
The US is a potential concern. With a salesforce now in the region of 80 in the US (up c. 50% on end FY22) to have seen only 34% constant currency sales growth in FY23 over FY22 raises a question mark. None of the analysts appear to have picked up on this, so far as I can tell. But it is the key result I'll be focused on in 1H FY24.
It is this question-mark which leads me to be cautious on the ultimate potential of the US market. (I max-out the US sales force at 150 reps. at about 2030. If US sales growth of >30% p.a. can be sustained for a few more years, then I will revise this upwards next year.) This upside possibility is not fully accounted for in my range of scenarios.
Europe
For me, Europe remains the untold story. UKI was a big surprise in FY23. Growth of +169% means this must be getting to total of around $3.50m-$4,0m in sales. (Of course, by comparison to ANZ, an equivalent penetration would be more like $12m at a comparable stage, so there is a lot further to go.) Germany grew +192%, but this is via a distributor, and off a very low base as to probably not be meaningful.
Still, UKI and the EU is a high value market of some 450 million people and, even though a smaller $ market in aggregate than the US for medical devices overall, it is still very significant and largely untapped by $PNV. In all my scenarios, I assume a direct sales model for Europe but a slower build-up over the 10-year period. So, there is the potential for upside to all scenarios, particularly if the latest UK experience leads to management getting more serious about Europe. (C’mon on Swami, you can do it!)
Ongoing Visibility
It looks like $PNV are going to disclose sales on a US and RoW basis only going forward, with scatterings of informal disclosures to highlight individual market milestones or successes. I don’t like that because RoW is going to be a blend of 1) long term developed markets (like ANZ and UKI), 2) new developed markets like (EU, Canada, and Japan) and 3) developing markets, primarily India and China. This is going to make it hard to track how things are going for us analysts. However, the good news is that the US will give good insights into clinical adoption, market penetration and competitive positioning … and for the rest, we’ll just have to extrapolate! Hopefully, we will soon be able to get intelligence on realised prices and volumes in India.
Range of Modelling Outcomes
Below in Figure 3 is a summary of the valuation outcomes. I’ve equal-weighted each of the 9 scenarios, and from the graph been able to read off p10, p50 and p90 estimates of value.
Table 1 summarises some of the key valuation metrics and multiples.
What I do know from all the modelling is that higher valuations can easily be achieved, and it is much harder to drive downsides much below the $1.40 - $1.50 range. This is the same conclusion I reached in 2022.
So, I am comfortable that today $PNV is significantly under-valued. It remains my largest SM position and at the top of my conviction list in my high risk holdings.
In RL, the great progress of $WTC, $ALU and $TNE (plus my doubling-down on $RMD against the shortselling-thesis), means it now only sits in 6th position at 4%. It is tempting to add more at these prices; however, it remains a risky proposition with a lot of execution risk. Often the best investment strategy is to do nothing.
Figure 3: Outcome of Valuation Modelling Scenarios
Table 1: Summary of Key Valuation Metrics*
* Note that the High value of $3.62 is higher than my quoted upper limit of $3.30. This is because the valuation range is read off the above chart at the p10% and p90% levels, and ignores any extreme individual valuation results.
Disclaimer
The above analysis is not valuation or investment advice and is for my personal purposes only. It is provided for information and to stimulate debate. The analysis is not validated to be free from errors.
Disc: Held in RL and SM
I know a few other StrawPeople follow $PNV closely. So this is a question of detail for them.
I've been trying to get my head around the statement: "U.S. NovoSorb sales $46.1m up 44.6% (34.0% in local USD)"
We don't get consistent reporting of numbers, so I have constructured the following table for US Sales in A$ and US$. (Warning - shaded numbers are my calculations and have not been reported by $PNV and may be wrong, particularly given that I am using an annual average FX when volumes vary significantly through the year).
The numbers I am focused on is the constant currency USD sales, %y-o-y difference.
My estimates of the FY-end US Sales Force (FTE) are as follows (note: not reported)
2021 = 36 (reported)
2022 = "54" (At end 2021, DW said Ed would add another 20,... I assume he came up a couple short)
2023 = "75" (And then the same again in FY23)
Note - the last two numbers may be inaccurate, but as far as I can tell, they haven't disclosed US sales force numbers for a bit. DW has thrown some numbers around, and there is as far as I can tell now a sizeable non-Sales US headcount. However, directionally, the numbers make sense given 218 total reported at 30-June-23.
Forget, the fine detail, but doesn't this point to a significantly slowing of US$ sales/ salesperson? We know it takes a year or two for new starters to ramp up their sales volumes. So, given the big increase in numbers over the years, shouldn't there be a sizeable lag effect as productivity of sales staff added 2 years ago continues to grow. So, however you cut it, incremental USD sales of $7-8m FY22 to FY23 appears light.
Maybe something structural is happening. Maybe the initial workforce covered high-use burn clinics, and now incremental workforce are hitting lower returns, with new accounts being less valuable in general hospitals. (By the way, that is an entirely rationale sales and marketing strategy.)
IF (and it is a big if) this is real, its going to masked in FY24 by big numbers coming form emerging markets, and we won't find out until some time down the track that saleforce productivity or market penetration is flattening off.
I feel like I am having to play Hercule Poirot here, and just wish they were more consistent in their reporting. But before I fire off a missive to DW, has anyone else sensed anything?
Has anyone else had a look at this?
The purpose of this straw is to review the progress of $PNV in the context of its sector competitors. It contains some analysis of possible market evolution. Although somewhat academic, it may be of interest to holders of $PNV, $AVH and $ARX, so I’ve decided to publish it. (Sorry its such a long one, but I do this kind of analysis on my top holdings and I don't ahve the appetite to edit it down.)
I have done the work to further my own understanding of the long-term growth assumptions in my $PNV valuation ahead of updating my company valuation later this year.
Peer Group
The companies in the sector considered are (the “Peer Group”): Aroa (ARX), Avita (AVH), and Integra (IART).
It is important to understand that across the Peer Group there is a wide range of products with a wide range of clinical applications including burns and complex wounds. These products are not today always in direct competition with each other. For example, $PNV’s BTM can be used for dermal repair in conjunction with $AVH’s Recell, which can be sprayed on top. In this respect they are complementary products. However, each of the companies is continually trying to extend its product portfolio and applications. For example, $ARX is used in complex wounds, which is a key area $PNV is trying to grow into from its existing base in burns. As of last year the CEO of $ARX said he did not consider $PNV a competitor. But I think that will change (is changing)!
Sales Growth
Table 1 below shows the revenue growth of revenue during calendar year 2022.
Table 1: Peer Group Revenue Growth 2021 to 2022
Source: Company Presentations and Accounts
Notes:
1) Because of the $ARX reporting calendar, I have used growth in cash receipts as a proxy and triangulated this with its target revenue growth for FY23 ending in April 2023.
2) $IART has a more complex portfolio of products. Fortunately, in segment reporting it breaks out sales for its “Total Tissue Technologies” segment. So, I have used this.
Observations from the table
$PNV: Is easily the fastest growing in the Peer Group. In addition, we are yet to see the impact of the accelerated ramp-up in sales and marketing personnel and territory expansions following the December capital raise.
$AVH: announced that they expect FDA approval for Soft Tissue and Vitiligo applications of Recell in June 2023 and to be ready to launch on 1-July. They have identified the Vitiligo market to have a patient population of 5 x Burns and Soft tissue repair (see Figure 2 below). As a result, they have announced plans to increase their US field sales organisation from 30 to 70 professionals. While their sales growth looks modest at 4%, this is masked by the large $8m BARDA payment in 2021. Excluding BARDA, commercial sales grew by 35%. In FY2023 they have given guidance of $49-$51m, which would represent 45% growth over 2022 at the midpoint. These factors have no doubt driven the recovery in share price over recent months. There is, therefore, the potential for very material growth for $AVH in a separate market in which other Peer Group members would not compete (Vitiligo).
In December, $IART acquired Strategic Innovation Associates (SIA), makers of Durasorb, an innovative resorbable synthetic mesh, for use in breast reconstruction. This complements the existing product Surgimed (a biologic) in Hernia repair and plastic and reconstructive surgery. CEO Jan de Witte said “Now with DuraSorb and SurgiMend, we have a path to securing the first and second PMA products in the market. And by offering 2 distinct product solutions to plastic and reconstructive surgeons, Integra can build a leading position by addressing various clinical, contracting, and economic needs across different sites of care.” From my previous $PNV straw, I noted that CEO Swami Raote has been more circumspect on the development timeline and certainty for the development of breast and hernia products. So, it appears that once again $PNV will be following a “next-to-market” path in the years ahead, with a synthetic mesh already established in breast reconstruction and potentially a biologic in hernia repair. It is further interesting to note that $IART now has a synthetic in its portfolio.
Market Size
I found the following slide (Figure 1) from the recent $AVH investor. It is interesting to note that $PNV performed about 8,000 procedures in 1H FY23, an annual run rate of 16,000. With 84% of commercial sales in USA, that means about 13,500 procedures were carried out in the USA. Given an estimated market size for the USA of 145,000, that points to $PNV having a market share of 9% (Note: this significantly greater than the number estimated below based on revenue share).
Figure 1: US Market
Source: $AVH Company Presentation 2023
Separately, the global TAM for surgical reconstruction and complex wound care is estimated by $IART to be $2bn and growing at 5-7% p.a. On a sales basis, the Peer Group total sales account for only 30% of the market, with $IART at 27% market share and $PNV at <3%. There are two reasons for this: 1) for many indications, including burns, the standard of care remains autografts or skins graft, which do not involve a dermal implant product and 2) there are other products produced by other companies not addressed in this analysis.
While the estimates for $PNV’s market share are very different based on number of procedures and market value methods, both are consistent in supporting what we know in that its market share is small (3-10%) and growing much faster (c 60% p.a.) than they overall market, which is currently adding c. $100-$150m revenue opportunity p.a. - much more that $PNV's current total sales.
Part of the discrepancy between the methods lies in that the procedure count method is focused on the US market, whereas the TAM analysis is global. Clearly, all members in the Peer Group are highly-focused on the US Market. However, while the largest market, it only accounts for 43% of the global medical devices market. Western Europe is 24% and Japan is 7%. Current revenues of all Peer Group members are highly US-focused (70%-90%).
Growth Scenario & Assumptions
The basic question I am interested to understand is how long and how strong can $PNV revenue growth be in a competitive context? i.e., are the current growth assumptions in my valuation meaningful in the context of the overall market size, growth, and evolution of competitors?
I have modelled several scenarios, and (for illustration) here present only one.
2022 market size is US$2bn, with revenue plugged in for $PNV, $AVH and $ARX aggregated, $IART as the market leader shown separately.
Because there are several other products in the market (e.g., competing with $AVH’s spray on skin cell solution) and other implants, although I haven’t identified and quantified these, I have put in a placeholder for the current market value of $50m growing at a steady 20% per annum. (I would update this should in the future I gain more market intelligence.)
The balance is assumed to be “Other Care Systems”. This includes the autograft (skin grafts) which is the current standard of care for many burns and complex wounds.
The overall market grows at 6% p.a., and IART grows at 7% p.a., in line with its corporate assumptions.
In a “Bull Case”, $PNV starts off growing at 50% p.a., with growth rate declining by 1.5% p.a., and the Peer Group Minors starting at 35% p.a. growth, declining at 1% p.a.
Figure 2 (below) shows the market evolution over the 10-year period for this scenario. Key metrics for 2022 and 2031 have been extracted from the chart in Table 2 (below).
Figure 2
Source: Simulation
Table 2
Source: Simulation Analysis
Of course, you can create any market evolution scenario you like, depending on the assumptions. However, this analysis has yielded the following insights.
- If $IART continues to grow in line with corporate goals, they will still be the market leader in 2031, with a market share of 29%.
- If $PNV continues to grow at 50% pa in 2023, with the rate of growth declining by 1.5% per annum to reach a growth rate of 38% in 2031, it will by that time almost match the sales of $IART ((US$981m vs $989m). Despite its success, in this scenario, given the head start of $IART, even if it sustains a decade of high growth it will still be #2.
- There is of course a potential SUPER BULL case, wherein synthetics are proven superior to biologics via comparison clinical trials. In this case, it would be conceivable that $PNV could take further share from $IART and $ARX. I have not modelled that.
- Over the coming years, as both the current market leader $IART and $PNV seek to grow, the existing market and its underlying growth are sufficient to accommodate both companies achieving almost $1bn annual sales by 2031, provided that there is a continual transition from the current standard of care to these therapies and that $IART and $PNV prove long term preferred solutions ahead of $ARX and $AVH and that no new disruptive technology emerges. (Continuing to scan the market will give early warning of this, in just the same way that $IART can see $PNV coming after it.)
- By 2031, if $IART and $PNV both succeed in achieving these results, the combined market share of these market leaders will be 58%, with room for $ARX and $AVH to have 10% market share each and 22% for others. This is not an unreasonable competitive market structure in healthcare, which space for 4 successful, profitable therapies.
- The revenue growth assumptions in this simulation ARE SIGNIFICANTLY HIGHER than the growth assumptions in both my current BEAR ($1.63/share) case and BULL ($3.28/share) case valuation scenarios.
- Latest period $PNV revenue growth of 62% (which does not include the impact of accelerated investments in sales and marketing) is significantly ahead of the simulation starting point of 50%. Provided at FY $PNV can sustain or even accelerate revenue growth beyond 62%, then a significant upgrade to the BULL CASE appears to be justified.
Conclusions
Simulation models and long-term projections can result in GIGO (Garbage-In-Garbage-Out). However, models can also provide valuable insights.
This modelling confirms that there is a justifiable BULL case for $PNV that significantly exceeds my current BULL Case valuation where the 2031 revenue growth rate is 19.0%, vs. 38% is the simulation presented here.
Such a BULL Case would lead to a valuation significantly greater than $3.28/share. Provided growth and margins results are confirmed at the FY23 results later this year, I expect a major upgrade will result in my next DCF update.
Doing this competitor analysis has provided me with valuable markers to track $PNVs sector peers, which in turn will continue to inform my valuation of $PNV.
Reality Check – Current Valuations
Of the peer group, only $IART is today a consistently profitable, growing business. Of the three small companies, $AVH and $PNV are yet break and $ARX has just broken even.
While clearly the strongest growing of the Peer Group, a lot of $PNV’s success is included in its lofty revenue multiple. So its share price will continue to respond in a volatile manner with each readout on revenues and costs, until it develops a consistent earnings trajectory – some years away. Shareholders will need to have an ongoing stomach for volatility, but my analysis indicates that the potential rewards are there.
It also follows that, because several analysts publish research based on available multiples, there will be occasions over the coming years when “Sell” recommendations are issue based on sector comparisons. We’ve already seen this last year. In addition, traders will trade. My approach will, however, cotinue to keep an eye on the long-term prize.
Table 3: Current Peer Group Valuations
Source: www.marketscreener.com 2023 consensus forecasts
Disc:
$PNV: Held IRL (7.2%) and SM (25%)
$ARX: Recently exited IRL and SM, to reallocate capital and manage portfolio exposure to this sector.
$AVH: Not Held; Watching
$IART: Not held
$PNV today released 1H FY23 Results ahead of the afternoon's analyst call. Note that top-line revenue numbers have been pre-released. As usual, this straw includes their highlights, my analysis and key takeaways.
Their Highlights
PolyNovo’s ASX release on 16 January 2023 pointed to record sales growth of 67.5%.
The half year audited results attached to this release show:
• Record 1H FY23 sales of A$27.3m up 67.5% on STLY of A$16.3m
• Total revenue including BARDA of A$29.5m up 62.2% on STLY of A$18.2m
• Strong growth in U.S. achieving 1H FY23 record sales of A$22.8m up 61.0% vs. STLY of A$14.1m
• ROW sales of A$4.5m up by 110.1% vs. STLY A$2.1m including new sales in Hong Kong and Canada.
• The Group recorded a net loss after tax of A$3.8m (1H FY22: A$1.6m profit). The profit in 1H FY22 included the reversal of A$4.7m in share awards and share options expense forfeited by the previous CEO and COO on their resignations and an unrealised forex gain of A$0.4m. Excluding these items results in an underlying loss of A$2.5m for the prior period.
During the Period, the Company’s other key initiatives and achievements include:
• A $53,000,000 capital raising
• First $5 million BTM sales month in September (Sep 2022: $5,402,454) recurring in October ($5,263,100) and December ($5,306,540)
• Appointment of CEO Swami Raote
• Received FDA 510(k) clearance for NovoSorb MTX
• Entered Hong Kong, India, and Canada markets in December
• Leased the adjacent property in Port Melbourne to significantly increase manufacturing capacity
• Commenced SynPath Diabetic Foot Ulcer Clinical Trial
• Awarded Victorian Government grant for manufacturing Diabetic Foot Ulcer product (SynPath)
• Increasing sales teams and customer base globally
• Produced for 1H FY23 the equivalent of 74% of the total devices produced in FY22
Analysis
Revenue
On revenue, these were pre-released, so there was no material new information. A breakdown of the monthly sales following the first $5m month in September, shows that both October and December exceeded $5m.
In terms of revenue drivers, Figure 1 (Slide 5) gives a good overview. Growth in Customers (Hospitals) and Employees (a large portion being sales and marketing) are leading indicators of future revenue growth, as it takes time for the sales to grow once both a new account opens and a new salesperson is in place. This should give confidence of a strong trajectory through H2. The slide makes the point that a return to >60% revenue growth marks the return to better customer access post-COVID.
Figure 1 (Slide 5)
Figure 2 (Slide 6)
On Figure 2 (above), I see that ANZ and RoW are now starting to become significant. At $4.6m in aggregate, they are about the same as the USA was in 1H FY19. While ANZ is relatively mature, it is still growing at >60% and we are yet to see meaningful contributions from Canada, Hong Kong and India. Interestingly, there is no mention of Europe beyond UK. So RoW should be expected to maintain strong growth as we start to get early traction in new territories. BARDA is also growing, so I wonder how far off we are from seeing a strategic stocking decision?
Costs
Today is all about understanding how expensive the cost of accelerated expansion is going to be.
Comparing 1H23 to 1H22, the incremental revenue was $11.2m, while incremental costs added are $16.9m. That sounds pretty bad on the face of it. However, the previous period included a credit of $4.7m reversing lapsed options of departing executives, so the underlying incremental cost is only $12.2m, by my calculation. While I am not a fan of underyling corrections - particularly when they happen every period - in this case, I hope we will see some management stability and so I'll let that adjustment pass. Overall, cost increases will always run ahead of revenue growth. So, the real test of this strategy is going to be in the FY23 and 1H FY24 reports.
Of course, it is important to remember that we haven’t seen the full effect of the step-up in cost base as the changes in increased staffing occurred through the half. We’ll see the full effect in the H2 numbers at FY. I expect to hear some questions on this from the analysts on this afternoon’s call about a forward view on cost evolution.
Profit and Cash Flow
Unexpectedly, therefore, we’ve seen a small increase in losses to $(2.2)m.
FCF was $(3.1)m compared with $(3.7)m in the PCP (note: I'm deducting lease costs from the FinCF line from OpCF), so in the context of now having $50m in cash available, the cash burn is sustainable. Of course, in FY24 and FY25 we are going to see a step-up in capex, as new facilities are built. However, if revenue continues to grow at current rates, the cash generation should mean that cash reserves are not eaten into that much.
My Takeaways
With revenue numbers pre-released, and the capital raise clearly indicating that SR had moved DW on from the “boot-strapping” strategy (no doubt a condition of SR’s joining), today was always going to be about how much costs are stepping up to drive expansion. Because of timing, we are only getting a first view of that.
Overall, it’s a bare-bones, no-nonsense presentation, which I personally find refreshing. It will be interesting to see how it is received. The analysts have been used to getting more granular detail, so I expect there will be more digging in the Q&A, as analysts try to get their FY numbers right. (I’m looking forward to the tussle!)
I am happy with the progress shown in this report. Nothing has a material bearing on my valuation, which sits at $2.46 (being the average of distinct bull and bear case DCF scenarios.) I will wait to do an industry read across including Aroa, Integra and Avita reports to see if this offer any insights on competitive positioning over the coming weeks.
Disc: Held IRL ( 6.8%) and SM (22.9%)
Further to @GazD posting the $PNV presentation to the JP Morgan Healthcare Conference in San Francisco today, while the presentation contains no material new information, it is a good up to date overview of the business with summaries of market focus (including where we can expect movement in the near future) and product portfolio.
Over the last 1-2 weeks we have seen the SP increase by over 30% from the capital raise price of $1.90 on NO NEWS whatsoever.
The SP at writing of $2.48 is bang on my latest valuation of $2.46 from 4 months ago - so I am a clear HOLD, even though it is easily my largest holding in SM (24%) and RL (10%).
A word of warning, however, if H1 results don't exceed lofty expectations, there could be a significant pullback. We have some way to go until $PNV becomes a reliable performer. Being close to breakeven, the actual profit number might be finely poised between continually increasing revenues and cost expansion due to i) expensive seniors hires ii) R&D buildout and iii) the broadening of the sales and marketing footprint. Impossible to call where it will land, so if you are interested in the stock then be prepared for moves either way and don't be surprised by downside volatility. These short term moves are of no real interest to me, as I hold with high conviction for the long term.
I'll review my valuation after the 1H results in a few weeks time.
In addtion, it is worth noting that short interests (see below) have been progressively falling - the reduction over the last 6 months representing a sigificant withdrawal of supply of shares from the market, and going some way to explaining the SP strength.
I am very much looking forward to hearing Swami and David deliver the $PNV FY22 Results tomorrow.
Whatever the results, it will be hard to call the price action. Shorts (graph below) have been reducing given positive updates(Q3), DW share buying spree and a strong CEO appointment. However, taking a 3-year view they remain high at 6.78% as of last week - there's a possibility for strong movement either way, depending on response to results.
Analysts don't know what to think or haven't updated. SP is 22% above consensus (n=6, marketscreener.com, range $1.11-1.90). I'm at $2.80 (central case, DCF, will update on SM after I have digested the results).
Consensus on sales is $42m, but my estimate is $43-48m range.
With DW's last purchase reported on 9 June, and with his strong buying through Q4, I assume the sales trajectory will be strong.
Cash flow will be at or close to breakeven, before including proceeds of real estate sale.
A few uncertainties impacting cash flow are impact of wage increases and inventory changes to support sales, although according to Swami $PNV is being sought out in the sector as employer of choice and according to David, supply is easy due to very high %GM, so no need to hold significant local regional stocks now that borders are free flowing again.
Here is the link to the results call, tomorrow at 2:00pm:
https://services.choruscall.com/mediaframe/webcast.html?webcastid=DVUbmPqJ
Disc: Held.
On both SM (18%) and IRL(7.4%), $PNV has become my largest position, even after trimming along the way. My conviction on this firm is such that I am going to let my winners run.
from www.shortman.com.au
