Nanosonics: Result 2015

Nanosonics increased revenue a paltry 3% for the year to June, but this was mainly due to lower sales to the company's US distributor, GE Healthcare, as Nanosonics transitions to a direct sales business model in the region. The company posted a net loss of $5.5m due to the investment needed to get the US operation up and running. With a cash balance of $46m, though, the company still has plenty of funding for its immediate growth plans.

'Nanosonics' North American direct sales organisation has now been successfully established. Recruitment of all sales territories is complete with all sales professionals trained and focused on building the pipeline for direct sales. Warehousing, service operations and order procurement facilities are now in place and operating effectively,' said chief executive Michael Kavanagh.

Sales in Europe continue to grow, with a particularly strong showing from the UK. The National Health Service (NHS) Wales recently released new decontamination guidelines for ultrasound probes, which will continue to benefit Nanosonics as hospitals review and upgrade their existing cleaning procedures to automated systems (see Nanosonics' dirty little secret).

The company's gross margin increased from 65% to 69% due to increasing sales of high-margin consumable products, such as disinfectant containing cartridges. Nanosonics' business model is like that for desktop printers – the operating unit is sold relatively cheaply, but then the customer is locked into buying high priced refills. Nanosonics now has an installed base of more than 5,000 trophon EPR units and, as this number grows, so too does the proportion of recurring earnings.

Nanosonics' share price has risen 8% since Nanosonics' dirty little secret from 18 Jun 15 (Hold – $1.58) and has more than doubled since we first upgraded the stock in Nanosonics builds a better mousetrap on 10 Mar 14 (Speculative Buy – $0.785). Today's share price is just 14% below our recommended Sell price of $2.00 and it wouldn't take much in the way of good news for it to blow through it.

Nanosonics' sales are now ten times what they were in 2011. It's notoriously difficult to pin down a precise valuation for fast-growing companies, so situations like this are something of a grey area. If Nanosonics' direct sales model is successful, sales could grow even more quickly over the coming years as GE Healthcare currently has significant negotiating power over prices.

However, a direct sales model is a far riskier strategy as Nanosonics doesn't have an established track record. The company isn't as durable as a Cochlear or ResMed so we highly recommend taking profits as the share price increases and we recommend keeping a close eye on our maximum portfolio limit of 2%. This will allow you to own shares in a rapidly growing business if things go to plan, while ensuring you bank a decent profit should the company under-deliver. HOLD.    

Note: Our model Growth Portfolio owns shares in Nanosonics.