Why HSKA Could Double in 2014
Overview
Heska (HSKA) distributes veterinarian capital equipment and consumables to both distributors (MWI Veterinary Supply, Inc. (MWIV), Patterson Companies Inc. (PDCO), IDEXX Laboratories, Inc. (IDXX)) and independent veterinary practices. The company has had a choppy and inconsistent history, booking net cumulative negative cash flow since inception in 1988 and a cumulative net loss of $24 million on a tax-adjusted basis since 2001. While HSKA does not have a stellar history, I believe the stock is on the cusp of breaking out to the $12 - $14 range, or a near double from today's price. Valuation is cheap, and profitability is poised to go much higher. Growth appears to be set to sharply accelerate beginning in the current 4Q. There have been multiple key catalysts throughout 2013 (some more subtle than others) which lead me to believe this is the case:
- November 2012: HSKA penetrates the first line of defense in the veterinary capital equipment distribution channel via a new agreement with MWI Veterinary Supply. MWI has a 484-person sales force, over $2 billion in annual revenues, and estimates animal health products for calendar year 2011 had a market size of nearly $8 billion.
- February 2013: HSKA announces key acquisition of 55% of Cuattro Veterinary and rebrands it as Heska Imaging. Cuattro carries a strong line-up of cloud-based digital imaging equipment. HSKA brings on Cuattro's sales and management teams… Cuattro management owns 4% of HSKA at deal-close and most of the minority Cuattro shares. HSKA has call option on the rest of Cuattro with staggered exercise dates lapping in 2015, 2016, and 2017. Language in the legal filings re. the merger agreement suggests very strong Cuattro results in the out years.
- June 2013: HSKA announces agreement with Elanco Animal Health, the fourth largest animal health company in the world, exchanging non-core assets from its OVP business. HSKA may have other extremely valuable non-core assets it would be willing to part with to shore up its balance sheet and/or finance the rest of the Cuattro deal. This could potentially be a profitable gateway for HSKA and could open the door to great business between the two companies.
- November 2013: HSKA announces solid 3Q13 results with modest top-line growth and break-even operating results (major change relative to recent trends). Management provides color on new sales and marketing initiatives, Cuattro integration, and analyzer placements (the main type of capital equipment HSKA sells). Earnings power appears to be accelerating rapidly, and will go much higher as comps become easier, NOLs of over $100 million kick-in, and operating leverage becomes more visible.
New Partnerships
The MWI agreement speaks for itself. MWI is a dominant distributor and Heska has never had access to its stock prior to November 2012. This is a positive for Heska no matter how you slice it and can be thought of as a call option on the stock, as it isn't really central to the story and would also be difficult to predict how valuable this could be over time.
The Elanco agreement is important for a couple of reasons: (1) it validates HSKA's technology and non-core assets, and assures shareholders they do indeed have value, and (2) it adds liquidity to Heska's balance sheet, improving ROE which leads to a move above book value (which is currently ~$7.92, meaning HSKA shares sells for a 9% discount). Management was pleased with the agreement, I quote: "We are pleased to announce our first formal relationship with Elanco, the fourth largest animal health company in the world… our recently announced relationship with Eli Lilly's Elanco organization provides us with a blue chip vaccine partner, aiding us in our OVP business."
While the agreement with Elanco called for Heska to sell non-core technology assets, it looks like the company likely owns property worth over $2 / share (conservatively by my estimates). Per Heska's 10-K: "Our principal production facility located in Des Moines, Iowa, consists of 168,000 square feet of buildings on 34 acres of land, which we own. We also own a 175-acre farm used principally for testing products, located in Carlisle, Iowa." This could conservatively be worth over $2 per share at roughly $50 / square foot and $10,000 to $20,000 per acre of land. Management has shown willingness to divest non-core assets in the OVP segment before, plus it's not a huge piece of their business (roughly 15% of revenues) and has a relatively worse profitability profile (margins are lower and sales seem to be more volatile). Heska has also paid dividends and repurchased stock in the past, so I wouldn't be surprised to see this happen again if they can add some cash to the balance sheet via monetizing the land or doing a sale / leaseback deal on the building.
Cuattro Acquisition is Key
Heska acquired 55% of Cuattro Veterinary in February 2013 and immediately rebranded it as Heska Imaging. Cuattro carries a strong line-up of cloud-based digital imaging equipment. Heska brought on the sales and management team, and the latter now owns between 4% and 7% of HSKA's outstanding shares. There are a few key themes we need to review in order to fully understand what's going on:
First, HSKA now has complementary analyzer and imaging equipment, and can sell a bundled solution with discounted consumables (vets need both so they can diagnose the animal and then physically view and document x-rays, and then upload this info to the cloud). This is absolutely crucial for the following reason, which management consistently harps on now that the companies are combined, and I quote: "one of our key competitors in the analyzer business lacks both ultrasound and digital x-ray products, while the other does not have an ultrasound offering." Management is also on the record saying "Given that one of our key competitors lacks this opportunity and entry point, we believe the opportunity can be very meaningful." Not only does this offer HSKA significant leverage in the MWI channel as well as in its own independent distribution channel, but I believe it also makes HSKA a very attractive buyout target for someone like VCA Antech, Inc. (WOOF), who badly needs more product so they can sell a bundled package to vets, as they have lost lots of market share on the lab side to a third competitor, ABAXIS, Inc. (ABAX), who currently offers a bundle.
Second, HSKA's management made a couple of key decisions… first, they cross-trained both the Heska and Cuattro sales forces on each other's respective product lines, so they can be bundled and sold more efficiently. Second, they introduced a rental model whereby vets can rent the equipment on a 5-year term in monthly installments of "substantially less" than $1,000 per month. The economics are extremely attractive for HSKA, as the company now has a recurring revenue stream and ultimately a more predictable financial model. The results have been astounding over the last two quarters… on the 2Q13 conference call, management provided placement statistics on its capital equipment for the first time ever, noting 91 placements in June alone versus a total of 153 in all of 2Q. On the 3Q13 call, management reported significant acceleration: the company placed 236 analyzers (+54% sequentially), and made it explicitly clear that these are all being placed directly with end users (independent vets), and are not simply being stuffed away into distributor channels. What's even better is that management noted "strikingly improved" sales force efficiency, with a double in analyzer placements per sales rep. This will enhance operating leverage as Cuattro acquisition costs lapse in early 2014. Additionally (and more importantly), CEO Robert Grieve made it clear that Heska's equipment placement rate "isn't anywhere close to getting to maximum velocity." At $400/month in lease payments and a run-rate of 800 total placements in 1 single year (conservative as this is below 3Q's run-rate and 4Q is going to be "very robust" per management's comments due to vet capital spending seasonality cycle), we are looking at $3.8 million in high-margin rental revenues which would be shielded by Heska's huge NOL balance (over $100 million), resulting in substantial accretion to EPS. I would estimate the impact could be as high as $0.40 per year in EPS, or $5.40 per share value after applying a 15x multiple.
Third, Cuattro results have already begun to show marked improvements and acceleration in revenues. While 3Q results were solid, growth in operating expenses masked achievements made on the top-line. During the quarter, Heska recognized roughly $1.2 million in operating expenses from Cuattro that continue to pile on… this computes to nearly $1 per share on an annual basis. As these begin to lapse as soon as 1Q14 (Heska doesn't see a need for short-term G&A expansion), Heska's newfound go-forward earnings power will be revealed and the stock should react favorably.
Fourth, 4Q will likely be a blow-out for several reasons. The comparisons are relatively easy ($18.5 million revenue, $0.07 EPS), and 4Q is always Heska's seasonally strongest quarter while management has already noted it should be "very robust." The biggest factor though will be internal sources, including better sales force productivity and continued momentum in the Cuattro business. Heska will have two solid quarters of strong analyzer placements behind it with stronger high-margin rental revenue flows, which should become more visible on the bottom line.
Fifth, when Heska forged the deal to purchase Cuattro, the companies agreed to provide Heska with a call option whereby it could purchase the remaining 45% of Cuattro with staggered exercise dates lapping in 2015, 2016, and 2017. Language in the legal filings suggest very strong performance from Cuattro in the out years:
(click to enlarge)
Cheap Valuation
Heska is extremely cheap on a comparable basis, especially when taken in light of recent developments I've previously outlined which will push profitability much higher over the next few quarters. HSKA prices at 0.8x revenue, while WOOF, IDXX, and ABAX price at an average 3.2x revenue which would peg Heska at over $35 per share. I do not believe that is reasonable, as Heska has not demonstrated anything close to consistent profitability or operational success since inception… however I do strongly believe that in light of improving fundamentals and profitability, hidden and unrealized asset value, and key competitive positioning now that HSKA can bundle and discount, the stock will re-price much higher, likely in the $12 - $14 range which would be between roughly 70% and 100% upside from here.
Risks
Obviously if the economy goes sour, vet capital spending will likely fall. Second, intense competition in HSKA's distribution channels (i.e. MWI) could stifle any potential growth outside of analyzer placement success (remember, these are being placed with end users and not distributors and I have not even accounted for this new distribution relationship in my valuation and analysis of HSKA's earnings power). I could potentially see some type of widespread recall issue relating to analyzer or imaging equipment as a risk (HSKA is just a distributor and doesn't do its own manufacturing), although the 10-K states that no single supplier accounts for over 25% of HSKA's revenue.
Summary
HSKA has made some key strategic decisions in the last 12 months which will serve to drive revenues, earnings, and ROE substantially higher over the next several quarters. The company has gained a key competitive position within its respective industry (which has healthy and secular fundamentals), and will now be able to demonstrate significantly improved earnings power or potentially be bought out. Cheap valuation and hidden assets serve as a margin of safety for potential investors. The company is also an attractive takeout candidate for someone like WOOF who lacks competitive product offerings HSKA has been able to acquire via Cuattro.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
This entry passed through the Full-Text RSS service — if this is your content and you're reading it on someone else's site, please read the FAQ at fivefilters.org/content-only/faq.php#publishers.
from SeekingAlpha.com: Home Page http://seekingalpha.com/article/1860661-why-heska-could-double-in-2014?source=feed
Aucun commentaire:
Enregistrer un commentaire