Shares in Azure Healthcare (AZV) have fallen 30 per cent over the past few months to today’s close of 24.5 cents, as shown in the graph below.
The recent share price weakness is at least partly due to aggressive on market selling from a prior top 10 shareholder.
We maintain our positive view on the company, with the stock trading at a large discount to our 44 cent valuation.
Patience is required with Azure as the market is waiting to see more evidence that the large R&D investment (all expensed) and new manufacturing facilities in the US will create long term value. There are four medium term opportunities that this investment program is likely to create.
- The product offering stacks up well against US competitors and, as such, the US based manufacturing facility allows relatively easy market share gains. Executive Chairman Robert Grey and his team maintain their view that they can double North American earnings each year for the next 3-4 years.
- The development of new integrated nurse call software related products is likely to eventually lead to selling a licensing based service to some of the company’s larger hospital based clients. The new products will promote some much needed efficiency gains within hospital clinical workflow systems. To convert even a very small percentage of current hospital customers to a software based licensing model would result in a step change increase in revenue and margins.
- There is an opportunity to cut costs from duplicated manufacturing and R&D facilities. With the new facility up and running in Austin, Texas it may be only a matter of time before the domestic manufacturing facility in Perth is shut down. The company has noted that manufacturing in the states is significantly cheaper and has additional capacity there.
- Management has gone through the 1-2 year process of registering its products with the FDA and receiving UL 1069 certification. This combined with the fact the company is only in the early stages of capturing increased US earnings makes it a potential takeover target. The integrated hardware and software based nurse call systems that are in 8,500 sites provide an excellent platform to leverage additional software based products.
FY 2015 Earnings
As previously noted, there is timing risk with Azure earnings due to the lumpy nature of contracts. In the first half it was stated that $5.5m of contracts had been deferred, but it is still expected to be reported in the next 6-18 months.
Our expectations for the full year net profit result are between $2.5m to $3m, depending on the timing of contracts. Further, there is ongoing risk of higher US expansion R&D and labour costs that are all expensed.
Even the lower end of our range ($2.5m) would be a good result given the first half was $0.9m, and most years earnings are weighted to the first half.
The first half ended with net cash of $1.8m. The deferred revenues may stretch this net cash position through working capital requirements in the second half.
In the first half expensed R&D increased to $1.874m vs $1.2m last year, and additional production staff increased costs by $0.55m. We expect the high R&D costs to be maintained and possibly increased through FY16. Importantly, we believe the increased investment will translate into higher return on equity in coming years.
Clinical workflow opportunities (healthcare)
Globally there is a common theme that hospitals and healthcare facilities remain inefficient and mostly not digitally connected.
With Azure’s products in 8,500 sites globally there is a huge opportunity to leverage these existing relationships and create further opportunities as demand for more efficient processes increases.
Some of the opportunities to integrate systems and technologies include Patient Electronic Records, Real-time Patient Telemetry, Admissions, Discharge and Transfer software, Real Time Location Services, Patient Flow, Touch Tablets, Smart and Wireless telephony.
The US is of particular focus considering it contains a much broader number of clinical, facility management and wireless telephony suppliers and the integrations require deeper levels of sophistication.
They are also leading the way with clinical integration and workflow management. The market is more commercially focused, and increasing the demand for operational efficiencies at a greater rate than elsewhere.
These are key reasons why Grey and his team have prioritised growth into North America.
Further, the US nurse call system market was valued at US$256.4m in 2014 and is expected to reach US$497.3m by 2019, growing at a compound annual rate of 14.2 per cent.
Given these industry opportunities and the approach management is taking to investing in its capabilities, we are confident it will lead to increased shareholder value over the medium term.
There is uncertainty with the timing of the four catalysts we have highlighted. As such, a 2-3 year investment view is required. FY16 is likely to continue the theme of higher expansion related costs. There is also uncertainty as to when the company will cut the duplicated cost facilities in Australia, and/or when they will be ready to achieve recurring revenues from software licensing.
However, from a risk/reward perspective we believe it is worth the wait given the very realistic opportunity to at least double earnings over the next 2-3 years.
On April 23, 2014 Azure received a takeover bid when the share price was $0.36. Although not confirmed, we had assumed this was Hills Ltd (HIL) given they had previously acquired two of Azure’s smaller competitors and had publicly stated they were on the lookout for further acquisitions.
The HIL share price has declined about 60 per cent in the last year, and last week the company announced the departure of chief executive Ted Pretty. Whether or not this changes HIL’s attitude towards acquisitions remains to be seen.
We maintain our “buy” recommendation with $0.44 valuation and continue to view the share price weakness as a medium term buying opportunity.
To see Azure Healthcare's forecasts and financial summary, click here.