James Faulkner on Immunodiagnostics Holdings: value on offer despite another profits warning?

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Around a month ago I warned readers that Immunodiagnostics Holdings faced a considerable risk of a further profit warning, due to the fact that trading was now weighted to H2 and that the company faced negative trading momentum. Well, not long after I wrote those comments, the shares tanked on the back of yet another profits warning.

Management cited a continuation of unfavourable short-term trends and weakness in placement rates, which are not expected to to pick up materially in the near term. Consequently, the firm said it anticipated that revenues for the year ending 31st March 2015 would be below current expectations and in the range of £45m – £47m. A first-half trading update issued yesterday showed just how bad the first half was, with the weakness spilling over into automated revenues, which posted a 9% decline.

However, returning to my September piece on the company, I also said the shares were worth watchlisting for this very reason, as I believed any significant weakness could be used as a buying opportunity for the following reasons:

1) Manual sales will eventually drop out as a main component of revenue, thus allowing revenue growth to accelerate as it becomes increasingly weighted towards rapidly growing automated revenues.

2) Diagnostics companies like IDH will have a key role to play in addressing the pressures faced by public health administrations, as they can help tackle health problems before rather than after the event.

3) Due to their annuity-like revenue streams, diagnostic companies can attract high take-out multiples (note Axis Shield back in 2011).

4) Longer term, the launch of the Mark II machine and the planned introduction of 80 new assay tests over the next five years should reinvigorate growth.

So where do we stand now?

Immunodiagnostic’s fall from grace has been predicated on its exposure to the vitamin D testing market. Before the initial share price crash at the end of 2011, IDH generated a total of c.69% of its revenues from the vitamin D testing market (including c.29% from vitamin D automated). When fellow vitamin D tester DiaSorin called the top of the market, IDH was therefore heavily exposed to a de-rating, especially given that the stock traded on growth multiples at the time. IDH is still feeling the impact of increased competition in this market, but vitamin D testing is set to account for just c.20% of total revenues in FY15 (according to Equity Development), dropping to c.6% by FY19. The name of the game going forward is diversification, both in terms of a broader range of tests and a wider scope of customers (both large and small).

Ultimately however, a return to sustainable earnings growth will be mainly driven by the launch of the Mark II instrument, which remains on track for the first half of 2015. The Mark II is cheaper to produce, and should appeal to the laboratory market through its ability to integrate into laboratory automation and tracking systems. In addition, it should open up new automated testing markets for the group. On this basis, and assuming the successful execution of IDH’s strategy, analysts at Equity Development reckon that compound annual earnings growth of c.27% is possible over the next five years.

So what about the numbers?

Current market forecasts assume FY15 will be the trough year for earnings, with market consensus at 14.6p. At the current share price of 295p, that’s a P/E of 20.2x. However, let’s not forget the £22 million net cash & equivalents on the balance sheet as at 30th September, which accounts for more than a quarter of the market cap, and offers significant breathing room for IDH to complete its transition.

I would also highlight the fact that brokers continue to expect IDH to remain highly cash generative throughout, with N+1 Singer expecting a free cash flow yield of 9.6% in FY15, 8.9% in FY16 and 10% in FY17, by which time expects net cash to reach £45.7 million (assuming no further acquisitions). So that’s a company that’s expected to have over 50% of its current market value in net cash within three years’ time, leaving a remaining business (ex-cash) ostensibly trading on just 6x prospective FY17 consensus earnings (23.1p).

Despite the hefty downgrades of late, Singer is one broker that recently upgraded its stance on the stock, from ‘sell’ to ‘hold’, on the basis that it believes “the shares have reached their low”.

Clearly, for those who take a positive view of the firm’s long-term prospects there is value case at current prices, albeit one that is predicated on a successful delivery of the firm’s diversification and growth strategy. The financial strength of the firm also underpins the investment case for those prepared to take a long-term view. In the meantime, a c.2% dividend yield is on offer for those willing to play the waiting game.

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