Hologic (NASDAQ:HOLX) is a pretty good example of an excellent company that isn’t always an excellent stock. When I last wrote about this diversified diagnostics and women’s health company, I thought there were good prospects for ongoing growth in diagnostics (molecular diagnostics in particular) on the strength of Panther placements during the pandemic, as well as recovery/normalization growth in Breast Health and Surgical, but I didn’t see a lot of upside.
Since then, the shares are up about 5%, outperforming most of its peers including bioMerieux (OTCPK:BMXXY), Bio-Rad (BIO), Qiagen (QGEN), and Siemens Healthineers (OTCPK:SMMNY), but underperforming the broader medical device sector despite financial results that have been on target to slightly better than expected.
I’d like to like Hologic more than I do. I think management is very good, I think the product portfolio is very good, and I see opportunities to grow internationally, gain further share in the U.S., and make selective accretive acquisitions. What I don’t see, though, is a lot of value – I think the shares are priced basically where they should be, and while annual upside potential in the 7% to 9% range is by no means bad, I don’t think that’s quite enough to argue for a “Buy” call.
Looking Back At Fiscal Q3 Results
Hologic has been posting modest, consistent beats, and were it not for issues in the Skeletal Health business that were outside of management’s direct control, the results would be even better.
Revenue rose about 3% as reported and closer to 6% excluding revenue tied to Covid-19, good for a very slight beat versus Street expectations. Gross margin was just a little shy of expectations at 61.1% (up 30bp yoy), while operating margin was likewise just shy of expectations at 31.2% (up 230bp, with operating income up 11%).
The Diagnostics business has continued to beat expectations, with sales up 6% ex-pandemic and about 2% above expectations. Adjusted organic molecular diagnostics (or MDx) sales were up more than 10%, with ongoing strength in the company’s share-gaining BV CV/TV tests (vaginal health panels) and in respiratory panels. Cytology and perinatal testing was down 3%, while blood screening was down 26% (but only makes up 2% of Diagnostics testing revenue).
Breast Health revenue rose more than 8% on an adjusted organic basis excluding the divested SSI business, good for a 2% beat. Imaging was up more than 8% as the company continues to deliver on a healthy gantry backlog.
Surgical revenue rose more than 6%, a small beat versus expectations, with ongoing strength in MyoSure and Fluent (a fluid handling system) and ongoing growth from Bolder as the company continues to pursue opportunities outside of Bolder’s pre-Hologic focus on pediatrics.
Last and least is Skeletal Health, where revenue declined 30% and missed expectations by 30% (or around $8M). The business has been hurt by stopping shipments of the Horizon DXA due to a supplier conformance issue. Long story short, it seems as though a tertiary supplier switched to an unapproved and non-compliant component and that has created issues with electromagnetic shielding (import for patients with pacemakers). It’s a manageable issue and the company is working with its suppliers, but it is having a temporary, modest impact on sales.
Optimizing Post-Pandemic Leverage
One of the best parts of the Hologic story in my view is how the company has run with the opportunities that the pandemic created. The company’s diagnostics business is 40% larger than it was before Covid-19, and the MDx business is more than 80% larger, with the Panther installed base nearly doubling from 1,700 in 2019 to around 3,300 now.
Better yet, these systems aren’t just collecting dust. Over a third of the base is using more than four assays on a regular basis, versus less than 20% before, and the success of BV CV/TV shows what a compelling new panel can do given that sizable installed base.
To that end, I believe Hologic has leveraged this strength to gain share from companies like Siemens Healthineers, and I believe this strength is likely to persist, particularly with Hologic looking to roll out additional testing panels over time.
Hologic generated substantial free cash flow through the pandemic (over $2B in FY’21 and FY’22 and close to $1B in FY’23), and that money has gone toward deleveraging, share buybacks, and building the business through M&A. Importantly, I don’t believe that the company has been tossing money at M&A just because they can afford to – the deals the company has done (Acessa, Biotheranostics, Bolder, Diagenode, Mobidiag, and Somatex) all seem reasonable as bolt-on transactions.
The latest, Endomagnetics, cost the company $310M for $35M in revenue, which is admittedly steep, but breast surgery localization and lymphatic tracing technology is very complementary with the existing business and given that most of Endomagnetics’s sales have been through indirect distributors, there’s a meaningful execution-based sales growth opportunity here.
The Outlook
The biggest issue I still have with Hologic is that I think management’s 5% to 7% growth target will be tough to reach. I’m looking for long-term growth of around 5%, and while I do think there are attractive opportunities in areas like MDx, there are limits to how fast you can develop new panels and how many panels can really move the needle on revenue. M&A could boost that revenue figure, but I don’t model in any assumed M&A.
As far as positive drivers go, new screening guidelines from the USPSTF did lower the recommended age of breast cancer screenings to 40 (from 50), but still recommend every other year screening (as opposed to annual screening that some want to see). New guidelines for HPV and cervical cancer screening will come out at some point, but I see more risk than benefit here, as the task force could opt to recommend primarily HPV testing versus the co-testing that is the current standard of practice.
On the margin side, Hologic isn’t going to enjoy the windfall profit margins that the pandemic allowed, so 40%+ EBITDA margins are not a reasonable expectation. Still, the margin of around 32% compares pretty well to most peers, and I expect that to improve almost a point to over 33% next year, with further growth still possible beyond that. I do think that free cash flow margin can move from the low-to-mid-20%’s to the mid-to-high-20%’s over time, driving around 6% annualized FCF growth.
Between discounted free cash flow and growth/margin-driven EV/revenue, I think Hologic trades pretty much where it ought to; discounted cash flow suggests high single-digit annualized return potential, while growth and margins support a 4.75x forward revenue margin that works out to a fair value of about $83.
The Bottom Line
It’s possible that med-tech, which has re-rated up off the lows of the fall of 2023 could re-rate higher, but I don’t like counting on that given that valuations are pretty close to longer-term normal levels now. Likewise, Hologic could outperform my expectations or find value-additive M&A. As is, though, I think this is a decent enough hold, but I don’t see the upside I’d like to see before getting more bullish.
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