Description

MLAB trades at 50x p/e for a best case 5-7% bottom line growth story which last quarter declined around 33% bottom line and had top line declining 6%.  The stock was added to the S+P 600 index today and the stock is at the same ridiculous valuation it was before showing a negative growth quarter in early June (and being ridiculously valued before that.)   The only plausible bull case is they make a huge amazing acquisition but I’ll note their track record is poor (they are currently putting into run off their last series of acquisitions in cold chain packaging) and their areas of focus have multiple potential acquirers and targets with already sky high multiples.  They have reasonable market share in their own businesses so synergies to be gained would be minimal. The valuation confounds me and I believe will confound anyone reasonable who digs in.    

Businesses in brief:

Biological Indicators or Sterilization and Disinfectant Controls (BI or SDC) - Just under half of MLAB’s revenues and gross profit . They provide testing strips to determine the sterility of various environments.  They service mainly pharmaceuticals but also hospitals and dentists. 3m competes in this space but MLAB claims to have higher quality and more diverse BIs. They claim to dominate the pharma research space (CMD (public company Cantel Medical) has a division called Crosstex that competes here and also in dental.  CMD has ramped up competition in Dental recently. It’s competitive enough in dental that they got caught fax soliciting without permission and got fined $3mm) They say that it is a small amount of spend for Pharma guys so they don’t really switch even though they admit there is nothing stopping the companies from switching.   I think it sounds like an average non-cyclical business and they will grow along with Pharma spend with a chance 3m or Crosstex (CMD) tries to take share at some point and disrupts profitability . Top line will grow a tiny bit more than bottom line. Last quarter this business shrank 5% and the CFO said it was because of a strong comp the prior year but it was down 2% the prior year’s quarter.  It grew 0% for the year. I am not sure if there is more going on here but I think it is equally likely 1q bounces back to 2% or so growth. If it doesn’t that would be a real catalyst because of the valuation. 

Instruments - A third of revenue and gross profits. Meters for dialysis machines, data loggers for food, pharma and medical, gas flow calibrators for industrial hygiene and bottle torque testers (tight bottle caps.)   This is more capital intensive and also more cyclical since it is instrument purchases. They say they have 90% of the dialysis market and their competitors are small and in niche markets. This business grew 6% in FYE 3/31/19 and 0.1% in 4q.  It bounces around quarterly and grew -1% the prior year and -4% the year before that. This is a slightly cyclical low growth business. 

Cold chain monitoring - 13% of revs and 10% of gross profits  Monitor temperatures for hospitals and pharma research and production.   Non-res cyclical as part of build out. It is a fragmented market with 3 competitors having 10-15% each.   Not that important to the business but also not that special

Cold chain packaging -  They acquired these businesses and they tried to sell it but said they could get more value in a run off.  It’s small and won’t affect anything going forward.  

Here are the last three fiscal years of claimed organic growth if I back out the volatile and to be shut Cold Chain packaging business:

FYE 3/31/17  -0.1%

FYE 3/31/18  +0.6%

FYE 3/31/19 +0.9%

Their claim of 2-5% revenue growth has not held up in a great economic environment.  They consolidated plants last year which helped margins a bit but otherwise there is nothing to get excited about.

Some side notes are they don’t do conference calls.  They also only offer adjusted operating income/share.  That adds back all their claimed one time charges (some legit like legal settlements and some less so like inventory obsolescence) along with stock comp and deducts the low D+A which exists and is a pre tax per share figure. You’ll see bloomberg often get confused and thinks it is post-tax and they don’t really have analyst coverage to clean it all up.

I get to around $4.9 in EPS for 2019 which deducts a normalized stock comp and a normal tax rate.   In 4q19, I have it as $1.14 versus $1.67 the prior year.

All-in, I think this is a case of it’s hard to see losing much and you could win big as the SDC business showed weakness in 4q and could be seeing competitive threats. Instruments and Cold Chain are somewhat cyclical.  All-in, I think it is average businesses showing some weak signs with a valuation divorced from reality regardless. If reality hits, it could trade at 15x p/e for a low growth and boring average business which would be $50-80 if 4q is any indication of anything to come.   

The short interest is relatively low at 6%.  

I have given up saying where could something like this trade.  At 30x p/e I would have said this was really high and 40x I would have said seems unlikely it trades to 50x p/e.  So now I’ll admit I don’t know. Without any background, even in today’s market, I would peg this as low 20’s p/e going into last quarter’s earnings and 15x after the quarter because of how choppy it was.  A stable low top and bottom line growth business can trade anywhere these days. I don't think this one is even that stable but the market has placed it there. That’s all I can say.

Catalyst

Index selling wears off

Next quarter shows continued weakness

At it's core, this is a valuation short but because of the index pre0buying (see 6/21 volume) and last quarter's weak earnings with minimal sell side coverage and the strong June market, I believe the market just completely missed it after the first day.