|Shares Out. (in M):||60||P/E||0||0|
|Market Cap (in $M):||25||P/FCF||0||0|
|Net Debt (in $M):||2||EBIT||0||0|
|TEV (in $M):||27||TEV/EBIT||0||0|
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Hamilton Thorne is a high quality, global lab instrument business that dominates its product niches and has been consistently growing revenues ~20% with strong operating leverage, yet trades for an unreasonably low valuation of only 11x FCF.
The current valuation is particularly surprising when you consider that around 65% of revenues are from the in vitro fertilization (IVF) market -- a market which possesses a long runway for future growth driven by developing market adoption, and is already recognized as a particularly attractive market by investors. The most comparable company in the public markets, Vitrolife, for example, trades for 50x earnings and 40x FCF.
Hamilton Thorne possesses many key investment characteristics, including:
a fairly steady business with low individual order risk (typical system is $30k in revenues vs $9 M in total annual revenues)
low customer concentration (largest end customer is less than 5% of revenues)
high geographic diversification
a leading #1 or #2 market position in virtually every geographic market for its two core product lines
high operating leverage (trailing gross margins of 64% vs operating margins of 12%)
seven consecutive quarters of double digit organic revenue growth
a very attractive future growth profile driven principally by IVF trends
over $33 M in NOLs which will shield income taxes for a very long time
Given these characteristics, I believe that HTL is easily worth at least 20x FCF, or $0.73 per share. Furthermore, should the broader market start to recognize that HTL is a highly attractive, almost pure-play on the IVF market, I can see the company receiving a premium valuation more in line with where Vitrolife trades.
Shares trade as HTL on the TSX Venture Exchange in Canada and as HTLZF on OTC Markets in the US. Dollar amounts are in Canadian dollars unless otherwise specified.
Two Market Leading Product Lines
Hamilton Thorne has two main product lines: precision laser systems and sperm analysis systems. The company does not explicitly break out the mix between the two, but lasers are the larger contributor and I believe comprise around 2/3rd of the business.
Hamilton Thorne’s lasers attach to a microscope and are used to essentially perform microsurgery on embryos. IVF clinics can use the laser to drill a hole in an embryo, cut out some cellular material, and then perform genetic testing on that cellular material. The laser is also used to make an incision in the egg as part of the fertilization process. The company actually pioneered this laser assisted IVF technique in the 90s, which is how their lasers became the industry standard.
Hamilton Thorne’s Computer Aided Sperm Analysis (CASA) system comprises hardware, software, and accessories for image-based sperm analysis. These systems are used by IVF clinics to identify appropriate sperm cells for fertilization. They are also used in other markets such as for toxicology testing, as well as stem cell and regenerative medical research.
The company’s two largest competitors are both private European companies: Research Instruments in the UK and MTG in Germany. As one might expect those companies are fairly dominant in their respective home markets, but in every other region Hamilton Thorne has a #1 or #2 market position.
Consistent Growth Driving Margin Expansion
Organic revenue growth over the last few years has been at least double digits every single quarter, and has averaged in the 15-20% range annually:
This, in turn, has driven very strong margin expansion as gross margins are high at 64%. In Q1 2013 the company was still actually losing a bit of money, but operating margins have steadily increased each quarter and are now up to 12% on a TTM basis. I expect future revenue growth to continue driving further margin expansion, and see operating margins easily exceeding 20%, as one would expect from a niche lab instrument business.
High Growth End Markets
Hamilton Thorne’s two main product lines are sold to three distinct end markets: IVF, developmental biology research, and animal breeding. The hardware used is essentially the same in all three; however, the software is customized for each market. The company has been able to sustain its high rates of organic growth in large part because these are all high growth end markets.
As mentioned previously, the IVF market comprises 65% of the business. The global IVF market is generally thought to be growing at a 10-15% annual rate, with similar rates of double digit growth expected over the next five years. This high rate of growth is being driven by a number of factors, most notably an increasing maternal age at first pregnancy, the advent of new procedures that improve fertilization outcomes, and increased wealth creation in developing markets which is driving 20%+ growth in these regions as they catch up to where North America and western Europe already are today.
Another 20% of the business comes from developmental biology research. Life science research in this area has been increasingly substantially, and most of the industry research I have seen pegs growth in the regenerative medicine market at 20-25% annually.
Finally, the remaining 15% of revenues comes from the animal breeding market. Hamilton Thorne’s business here today is focused on CASA systems but there are several potential laser applications that are currently being developed in cloning, semen sexing, and laser-assisted IVF that could greatly expand the size of this market for HTL.
Incremental Growth Opportunities
Management has spent the past few years putting the company on solid financial footing -- turning the corner on profitability and getting cash levels to $1.5 M -- and appears to finally be in a position to pursue some incremental growth opportunities that have the potential to accelerate growth even faster.
There are a number of internal research projects, such as proprietary slides, and small acquisitions that have very attractive economic characteristics, but the company wasn’t in a position to pursue until now. Management is particularly focused on increasing the mix of services and consumable sales, which today are 15% of revenues, but management feels can be increased to over 50% of revenues with time.
Having met with and spoken to the CEO on several occasions, it is clear to me that he is a very understated and conservative person, and I feel confident that he will be focused on making relatively low dollar, low risk investments in the business.
Hamilton Thorne’s revenue base is very diversified by geographic region, with 40% of the business in North America, 35% in Asia/Pacific, and 25% in Europe. They go to market primarily through a network of distributors in over 60 countries, which together comprise around 80% of revenues. The remaining 20% of revenues that is sold directly is mainly for new products and more cutting edge applications.
Valuation and Conclusion
When they report year-end results, I am expecting revenues for last year to come in around $8.9 M USD. I have modelled 18% revenue growth for this year, which is down from the 21-23% growth experienced over the past few quarters to be conservative. As a result, I am forecasting revenues this year of $10.5 M USD.
With fairly modest expense growth, $10.5 M USD in revenues should generate around $2.2 M USD in operating income. After subtracting around $170k in interest expense and converting to Canadian dollars, FCF this year should come in around $2.4 M, or $0.04 per share. The company has $34 M in NOLs ($28.6 M USD) that will shield the company from paying any taxes for a very long time. Also, I have used a fully diluted share count of 65.4 M shares using the treasury stock method to account for options and warrants that are outstanding.
Based on those figures, HTL is trading for only 11x FCF, which is far too cheap for a quality company with these growth characteristics. I believe that HTL is easily worth 20x FCF, or $0.73 per share, giving the stock significant upside from current levels. It’s important to note that even that valuation would be a sharp discount to the 50x earnings and 40x FCF valuation that the most comparable public company, Vitrolife, trades at.
Similar to my prior writeup on Xpel Technologies, this is a US based company trading principally on a Canadian exchange, doing absolutely no investor relations, which has caused the stock to languish in obscurity. And similar to Xpel then, I believe the company is now at an inflection point with a number of the same potential catalysts in place to help shrink the large current discount to intrinsic value: the company is now at the $20-30 M market cap level where it can finally attract the interest of smaller institutional investors, the initiation of investor relations activities like investor conferences, Q4 which just ended and has yet to be reported is seasonally strong and should be record results for the company, and finally an eventual uplisting to a major US exchange.
Initiation of investor relations activities like presenting at investor conferences
Record Q4 results
Eventual uplisting to a major US exchange
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