Description

Electromed, Inc.

Investment Summary:

We believe Electromed is a buy at current price due to following reasons:

• High gross margin business investing heavily in initiatives which will result in top-line growth in next fiscal year and beyond.

• Macro factors like changing demographics provide a tailwind to sustain growth.

• One of the three players supplying 98% of the products in a slow-moving category in medical devices industry.

• Executive management has turned around the company and repositioned it into a growth business.  We believe the new management is steering the company in the right direction to enhance shareholder value.  

Business:   

Electromed is a growing medical device company with a focus in developing, manufacturing, and marketing airway clearance products.  The company’s SmartVest System is available in two products:  SV2100 and SQL, and is predominantly sold to patients in the home care markets although they are also available for use in the hospital settings.  With new production launches, including SmartVest Connect and distribution of Aerobika OPEP, in 2017, Electromed offers a continuum of airway clearance therapies, providing patients with a wide selection of products.  For a detailed discussion, we refer you to the latest 10K filed earlier this month and the company’s investor presentation on the company’s website.

Investment Case:

Electromed was founded in 1992 and was IPOed in 2010.  The company’s SmartVest System was developed to provide therapy to patients with Cystic Fibrosis (CF).  Currently SmartVest is prescribed to patients suffering from neuromuscular diseases, bronchiectasis, amyotrophic lateral sclerosis (ALS), muscular dystrophy, cerebral palsy, and chronic obstructive pulmonary disease (COPD).  

Considering the limited resources available to the company, on top of the sub $50 MM market cap, the prior management did a poor job of allocating resources.  Sales teams were deeply unsettled and directionless as the former CEO, Robert Hansen, seemed to change their focus abruptly at his whim.   Also, the inexperience of the prior CEO showed during 2012 Q1 call when he started negotiating with an analyst to change his ratings from a sell recommendation.

Soon after, Hansen was fired and the company struggled to find suitable leadership for about a year.  They went silent, suspended quarterly calls, and reduced investor interactions. Not surprisingly, the stock price cratered by over 75%. The board finally hired Kathleen Skarvan, an experienced professional with turnaround experience to revive the company.  Under her leadership the company implemented a systematic plan – below are a few highlights:

• Prioritized the sales effort of company’s HFCWO therapy to Bronchiectasis by calling adult patient pulmonologists.  Figure 1 below presents the opportunity.  As can be seen below, less than 15% of patients are prescribed HFCWO treatment offered by Electromed or its competitors.  The HFCWO therapy was originally offered to patients with cystic fibrosis.  Starting FY 2018, company is stepping up investments in the bronchiectasis market with projected annual growth rate of 9%. We believe the Smartvest family of products (the main contributor to Electromed’s top line), with its superior solution, will have more than its fair share.

Figure 1: Electromed Market Opportunity

• Emphasizing bronchiectasis awareness among patients, payors, and providers is a key sales initiative put forward by company’s current management.  Furthermore, with the new initiatives, like the creation of a bronchiectasis advisory board and a study highlighting cost-effectiveness, management has increased the awareness of company’s HFCWO therapy.

• Improved sales efficiency through various initiatives, including carefully recruiting and training talented new hires, evidence-based sales approach, and highlighting success at clinical/market studies.

• Mindful allocation of resources based on evidence of success, reduction in manufacturing costs, and streamlining operations.

• Introduced the new Smartvest products like SQL and CONNECT.  

• Established a new partnership for commercial distribution of the Aerobika OPEP device to home care markets.  With this introduction, Electromed offers a continuum of airway clearance therapies in the USA.

• Instilled a holistic approach by offering an airway clearance solution instead of just selling a device.  Supplemented the company’s offering with value-added services like facilitating reimbursement and respiratory therapists.  Below is the comment by Skavran during an industry panel discussion.

“Don’t just think about your product as a device.  I learned this 30 years ago.  I am not telling anything different.  We don’t provide a product unless it is a device plus a service.  Whenever you are developing a device make sure you are thinking about a service aspect of your device as well.  Because now with ability for wireless monitoring, case management, therapy adherence all has to be taken into account when you are thinking of any technology any device…..think holistically.”

The company has the following tailwinds, which, along with a competent management in our view, will help realize its potential and benefit a long-term investor in the stock.  

• Favorable oligopolistic slow-moving industry with just three players – Hill-Rom, RespirTech, and Electromed addressing 98% market.  These are the same players ten years ago.   

• Adoption of products from Electromed and its competitors are likely to increase with a changing demographic in the US and the western world.  Respiratory illness is on the rise globally and is projected to grow further in the coming decade.

• Secular shift in reimbursement to fee-for-outcome is a tailwind as well.

Valuation

Electromed is a predictable business, like several others in medical devices industry.  In our view, the opportunity exists today because the market has not fully factored in the company’s earning potential that include the fruits of current investment phase.  Performance under the current management over past three years gives us the confidence that its investments in reimbursement, SG&A, and R&D will begin to pay off soon – by end of current fiscal quarter.  Company’s performance since 2013 under current management is the basis of our confidence that the latest investments will boost revenues in FY 2018 and beyond.  As discussed, the targeted markets have secular tailwinds, that along with Electromed’s renewed focus and new offerings, could benefit its topline growth and profitability in the coming years.

The company’s enterprise value is available at 11x FY2018 and 7x FY 2019 EBITDA estimates.  We believe FY2018 will be year of investment and benefits will accrue and will begin to show up in FY2019 and beyond. In our view, the stock could appreciate 30% in next 12 to 18 months as current investment translates into growth in top and bottom-line.

Risks

We consider an investment in Electromed as a low-risk proposition.  However, below are a few risk factors an investor should be aware of:

• Payor concentration.

• The company competes with a much larger competitor, although it has competed successfully so far under current management.

• Regulatory/recall risk.

• Execution risk.

Catalyst

• Improvement in quarterly top-line data will probably increase the visibility among small cap investors.

• A faster ramp in adoption of new products, including Aerobika, that can boost company’s performance beyond estimates.