OraSure Stock: Earnings Mix Continues to Pose Risks (NASDAQ: OSUR)
From the Office of the Portfolio Managers
At HB Insights, we cover the entire healthcare spectrum very well. We continue to uncover selective opportunities with space that provides oversized risk-adjusted alpha to equity portfolios. We covered OraSure Technologies, Inc. (NASDAQ:OSUR) at length several times in the past here on Seeking Alpha [most recently here and here] too, and upped our rating from a buy to a hold in the process.
We had positioned OSUR as a tactical long position in January FY21 amid organic revenue growth and a pivot into new assay markets, and we know the name very well after closing the position during FY22. Jump into the third quarter of FY22, and OSUR’s organic revenue growth has held steady as the tailwinds from Covid-19 continue to wane. This presents itself as a major risk for the future.
Investment Thesis Summary
Here we reiterate the sustaining note on OSUR. Our internal team noted continued risk to business revenue when factoring Covid-19 revenue out of the equation. Alas, Covid-19 continues to be the bulk of the revenue boost – and therefore earnings for the business – and we therefore remain coy about the name. Rate retained on an evaluation of $3.03.
Profits still hinge on Covid-19 testing
OSUR came in with a strong set of numbers in the last quarter with advantages over the consensus at the top and bottom. Revenue of approximately $80 million (“mm”) was up 39% year-on-year, underscored by higher revenue volume for the company’s InteliSwab Covid-19 test kit. In fact, InteliSwab revenue grew 95% year-over-year and drove a 20% sequential increase in gross margin for the segment. OSUR now has the capacity to produce approximately 1.6mm tests per week and expects its capacity to double by FY23.
Moving down the P&L, GAAP gross margin was 34.4% and a sequential decline from ~35% in the first quarter. Part of the decline in gross margins was a shift in revenue mix toward the low-margin diagnostics business, which saw phenomenal growth of more than 200% year-over-year last quarter.
Meanwhile, operating expenses increased approximately 69% year-over-year to $48.87 million, but the increase came from a non-cash expense of $10.5 million related to the variation fair value adjustments for acquisition considerations. As a result, OSUR recorded a GAAP operating loss of $19.97 million. Stripping out this non-cash expense from OPEX and the operating loss is approximately $10 million and the net loss is $8.8 million.
Additionally, as shown in Exhibit 1, the company recognized $43 million in “Covid-19 related revenue” in its revenue clip. This is a QoQ increase of $31 million and a similar quarterly increase of $31 million from the same period last year. This represents approximately 54% of net revenue, compared to approximately 21% in Q2 FY21. This fact makes us hesitant about the name, as our investment case around OSUR hinges on its ability to expand Covid-19 revenue into adjacent markets. However, to date it has failed to do so, and most segments actually saw a year-over-year decline in the three-month period of Q2 FY22, as also shown in Appendix 1 .
Exhibit 1. OSUR continues to generate significant percentages of net revenue from Covid-19 sources, with numbers increasing significantly year over year in revenue.
Additionally, as shown in Exhibit 2, removing the Covid-19 revenue contribution to the business, we note that quarterly net sales decreased by a total of 36% year-over-year. This has implications for the future. First, management noted on the second quarter earnings call that gross margin remains under pressure due to the shift in revenue mix toward the low-margin diagnostics business.
Second, revenue is primarily Covid-related and was down year-over-year ex-Covid-19, as shown below. Not to mention the US government’s recent policy to stop funding free at-home Covid-19 testing from September 2. -line anticipates and distributes its revenues more equitably across its core business.
Exhibit 2. Covid-19 revenue continues to underpin the bulk of OSUR’s revenue, while organic growth has seen a sharp year-over-year decline during the Covid pullback.
OraSure Review and Summary
The shares are trading at a discount of 1.08x sales of T12M and are offered at an attractive price of 0.8x book value. At this multiple, we would theoretically pay $3.78, suggesting that stocks may in fact be fair and reasonably priced at these multiples, rather than representing an attractive discount.
Additionally, the market priced OSUR at 0.88x futures sales, around 81% lower than industry media, suggesting that investors are pricing the company’s earnings below the sector in head for the future. This corresponds to current sales trends. The attribution of 0.88x to our FY23 sales estimate of $250 million set a price target of just $3.03, indicating a downward value gap. Previously, we valued OSUR at $2.54.
With these points in mind, our research team estimates a peak of $323 million for OSUR in FY22 and sees that number decline to $216 million by FY24 as the accretive impact of Covid-19 continues to decline. Although FCF remained negative, this was not supported by an adequate quarterly return on investment, and OSUR therefore continues to post losses below net income. We reiterate the holding note for OSUR pending further clarity on non-Covid revenue.