I write a fair amount about operationally geared companies, and with good reason.
That’s because once a business reaches the inflexion point whereby its gross margin earned covers all fixed operating costs, then a high percentage of the incremental gross margin earned on additional sales will drop through to operating profit after deducting variable costs incurred. Operating profits will then race higher and outpace revenue growth as the operational leverage of the business kicks in. Of course, one needs to identify companies capable of generating the requisite turnover growth in the first place.
The technology and healthcare sectors are good hunting grounds. That’s because many companies in this space sell patent-protected high-margin products that offer tangible benefits to customers. Most are not labour intensive, either, so incremental costs associated with generating additional sales are relatively low. In particular, I look out for cash-rich companies trading on modest sales multiples, thus providing attractive entry points assuming of course they can achieve a decisive move into profit. Building a decent recurring revenue stream is one way of doing so.
Moreover, the solidity of a stable and rising revenue stream explains why many high-margin technology companies end up commanding high earnings multiple, too.
Beating expectations by a mile
- Gross margin materially above consensus forecasts.
- Operating profit beats forecasts by almost 50 per cent.
- Net cash double forecast.
Crawley-based Inspiration Healthcare (IHC:120p), a fully integrated medical technology company with a strong focus on the high-growth neonatal intensive care market, has posted a major earnings beat on all levels.
With the company’s gross margin five percentage points higher than Cenkos Securities 43.6 per cent forecast, and annual revenues more than doubling to £37m, gross margin of £18m was £2.1m above analysts’ estimates and operating profit of £4.3m was almost 50 per cent higher, too. Adjusted earnings per share (EPS) of 6.9p increased 90 per cent year on year, and net cash of £10.7m (15p a share) was almost double forecasts. Last summer’s acquisition of SLE, a designer and maker of ventilators for neonatal intensive care, contributed £9.4m to revenue and there were £7.3m of one-off Covid-19 ventilators orders, too, but underlying revenue still increased 14 per cent. There is every reason to expect the positive trend to continue.
In the past seven weeks, the company has received regulatory approval in Japan and China for its enhanced top-of-the-range SLE6000 neonatal ventilator that includes features such as enhanced High Frequency Oscillatory Ventilation (designed for use with critically ill infants) and the OxyGenie ® patented oxygen control algorithm (helps maintain infants at their targeted oxygen saturation levels). The higher-margin product has already received £650,000 of orders and chief executive Neil Campbell says that the two territories generated £2.8m-worth of orders with the old model, suggesting decent growth to come from the current base. SLE received a Queens Award for Enterprise this week in recognition of its work in developing an infant ventilator with the OxyGenie closed-loop software algorithm. It can only help boost sales.
Sensibly, Inspiration is investing £2m in new facilities which will be operational this autumn to support additional growth capacity. The company is also making progress with its patented non-invasive, non-pharmaceutical respiratory device for apnoea of prematurity, aiming to sell it next year into a target market affecting 1.5m babies annually in the US, Europe and Japan.
I suggested buying the shares, at 75p, last autumn (Alpha Research: ‘Profit from a medical technology winner’, 27 October 2020), and on an enterprise valuation of 12.5 times cash profit estimates, I see ample upside to my 150p target. Buy.
A business primed for the ‘new normal’
- Operating losses slashed.
- Annual recurring revenue (ARR) increases 46 per cent.
- Small acquisition and additional hire boosts US sales drive.
Technology group Checkit (CKT:63p) has reduced full-year adjusted operating losses by more than half to £3.1m on 35 per cent higher revenue of £13.2m, an eye-catching 15 per cent outperformance of previous guidance (‘Technology stocks for the new normal’, 26 October 2020). Net cash of £11.5m was £1m higher, too.
Checkit’s workflow management software digitises the scheduling and reporting of operational workflows with a view to automating manual processes, increasing efficiency and delivering greater management insight. Despite Covid-19 headwinds impacting some customers, annual recurring revenue (ARR) increased by 46 per cent to £5.7m, driven by new customer wins in the NHS and food retail sector, as well as contract renewals on enhanced terms.
The accelerated pace of digital transformation brought on by the pandemic is clearly validating Checkit's value proposition in the new ‘normal’ as companies look to manage deskless workforces through data-driven remote monitoring, and automated systems surveillance. There are tangible cost benefits, too, for corporate customers in Checkit’s five industry verticals: healthcare, food and retail, facilities management, pharmaceutical and fast-food restaurants.
The acquisition of US-based Tutela Monitoring Systems and hiring of an experienced Software-as-a-Service (SaaS) executive (previously at Oracle NetSuite) to drive revenue generation across enterprise food and retail, and healthcare markets in the Americas is another positive.
Checkit’s share price has risen by a third since my last update, and the re-rating has further to run to my new target of 75p. That’s because Checkit could hit the inflexion point of operating profitability sooner than I had envisaged, a possibility is not reflected in an enterprise valuation of two times annual revenue, a 70 per cent discount to the UK software sector average. Buy.
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