An ASX healthcare darling with big shoes to fill: Will it rise to the occasion?

As a company often touted as the next Cochlear (ASX: COH), boy does Nanosonics (ASX: NAN) have a lot of work cut out for it.

The infection prevention company – which manufactures ultrasound probe disinfectors – has seen its share price go nowhere for almost three years under the weight of COVID-related issues, hospital staff shortages and weaker-than-expected cycle volumes.

Now, Nanosonics is trying to turn a new leaf with a North American direct sales model, a tsunami of upcoming product upgrades and an imminent new product launch. But will all this be enough to save its fledgling share price?

In this wire, Donny Buchanan, CIO and Portfolio Manager at Lakehouse Capital discusses Nanosonics’ half-year results, along with his view on the outlook for the company and healthcare sector.

Nanosonics first-half key results

• Revenue of $81.6 million, up 35%
• Global installed base of 31,120, up 11%
• Trophon 2 upgrades of 800 units, up 100%
• Total Trophon 2 units placed of 2,070, up 14%
• Gross profit margin of 78.9%, up from 76.6% on the pcp
• Operating profit before tax of $11.4 million, up 246%
• Free cash flow of $6.1 million
• Cash and cash equivalents of $99.3 million

Key company data for Nanosonics

Note: The interview took place on Thursday, 23 February 2023.

In one sentence, what was the key takeaway from these results?

The transition to a direct sales model in North America drove a small step change in unit economics for their largest market. Overall, a pleasing set of results.

What was the market’s reaction to these results? In your view, was it an overreaction, an under-reaction or appropriate?

Note: Nanosonics shares rallied 3.4% in early trade but closed only 0.2% higher on Wednesday.

It’s in-line with expectations and it should be given Nanosonics pre-announced most of the result on the 19th of January, so the markets had a month to digest that information. There was only a small amount of incremental new information released today.

Were there any major surprises in these results that you think investors should be aware of?

Maybe not surprises, but certainly incremental information. There was an update around the new product Coris, including reconfirmation that they plan to launch it in Europe and/or Australia this calendar year. There was also a bit more colour around the composition of sales across the first-half, which points to a good bit of momentum in the second half - which supports management's full-year outlook for revenue growth above 35%.

Would you buy, hold or sell NAN on the back of these results? Which do you prefer?

Rating: HOLD

It’s not conventionally cheap in a market where the cost of capital is being re-priced but extrapolating the second quarter run-rate, the business has some good sales momentum and that supports management’s outlook for pretty strong growth in the high 30s for the full year. It also helps that the distraction of the transition to a direct sales model is now behind them. They should reach $165 million, or better, in revenue for the full year with a little bit of operating leverage within that.

What’s your outlook for NAN and the healthcare sector over the year ahead? Are there any risks to these companies and the sector that investors should be aware of?

The healthcare sector tends to be more resilient than the average sector, but healthcare providers are still subject to the impacts of inflation and budget constraints, particularly in the private-dominated market of North America. If there’s more belt tightening, Nanosonics won’t be immune. You may see sales growth soften if economic conditions deteriorate. 

That said, Nanosonics has a significant opportunity in terms of upgrades from the first generation Trophon to Trophon2. There are around 9,000 units at upgrade age, which translates to approximately $100 million revenue opportunity in the medium term, on top of a growing installed base. 

There’s also Coris where its launch has been pushed out in the past. Management is talking about a launch this calendar year, whether it's this calendar year or the next, I’m fairly relaxed. In any case, it’s getting closer. The early indications are that the product will service a big problem and set some new industry benchmarks in terms of high level disinfection for endoscopes. So there is a risk that it gets delayed further, but in any case, it's getting closer. 

Overall, I think the medium term prospects for Nanosonics and healthcare are quite good.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

Rating: 2.5

The cost of capital has been repriced and it feels like there’s still some way to go. There’s a lot of uncertainty around and I suspect some more belt tightening will happen, particularly in the Australian economy over the next 12 months. 

The interest rate rises over the last 12 months are still to wash through the system and there will be impacts from that. So I think some of those consumer exposed areas could experience a slowdown in the months ahead.

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Disclaimer: Donny owns units in the Lakehouse Small Companies Fund that holds shares in Nanosonics Ltd.

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