My nickname is Mr. Google. A BLOCKBUSTER article from Seeking Alpha. (the author is named Matson)
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Zynex: Spectacular Turnaround, Conservative Investor Response (So Far)
Aug.17.17 | About: Zynex, Inc. (ZYXI)
William Matson, CFA
William Matson, CFA
Deep Value, micro-cap, nano-cap, small-cap
Thinknum Prize Winner
(265 followers)
Summary
Despite Zynex’s four consecutive profitable quarters, investors continue to price the stock cautiously, due to its qualified audit opinion, prior losses, and negative book value.
Q2-17 EPS of $.05 appears sustainable and growing. If this EPS is annualized to $.20, Zynex’s forward P/E is 5.5x at its current $1.10 stock price.
Zynex growth merits a premium P/E multiple. Revenues and income in Q2-17 grew 53.2% and 769%, respectively, since Q2-16. Midpoint of Q3-17 EBITDA guidance is up 10% from Q2-17.
Per Zynex’s CEO, the Q4-15 closure of Empi, Zynex’s major competitor, left a $250 million market void that ZYXI is poised to fill.
Though its revenues are at least one year away, the Zynex Blood Volume Monitor, a non-invasive tool for detecting internal bleeding in real time, could be a big winner.
Since I Last Reported On Zynex…
When I last reported on Zynex (OTCQB:ZYXI) (published 11/19/16), I recognized both the potential for substantial returns, as well as for catastrophe. The stock closed at $.28 the day before I submitted my report, and I noted that this was 2.7 to 3.2 times forward earnings (based on an annualizing of Q4-16 guidance). On this basis, ZYXI was a screaming bargain - but the accountants threw a bit of cold water on things by issuing a qualified opinion, due to the company’s going concern risk.
Given that it was in default on a multi-million-dollar credit line at the time, I acknowledged that they had a valid point. I was also wary regarding the chances of extreme dilution in the event that capital had to be raised on unattractive terms.
Since then, the company has deftly avoided the land mines I’d feared and achieved results exceeding my best case assumptions. The credit line has been repaid in full and alternative financing was secured. More importantly, Zynex has become a prolific generator of cash, with $1.9 million in operating cash flow during the first six months of 2017. Actual earnings for the first nine months of 2017 ($.12, in all likelihood) are poised to best the high end of my full-year projections ($.104) by a comfortable margin.
Somewhat surprising, however, has been the market’s still conservative response (despite a four-fold stock price increase) to these results. Given Zynex’s spectacular growth in revenue and earnings, as well as its prospects for future growth and the removal of its major risks, I would have expected it to be commanding a P/E multiple somewhere in the 20s (at the very least!).
The Horns and Pitchfork Effect
I’d imagine that most Seeking Alpha readers are familiar with the Halo Effect, which so often results in the stocks of glamorous companies (i.e. story stocks) trading at what turn out to be undeservedly high prices.
The flip side of this coin is the Horns and Pitchfork Effect. Though some companies with bruised reputations do merit the indifference they receive from Wall Street, others may possess significant amounts of value that the market has yet to recognize.
Such is likely the case with Zynex. When a company’s most recent audit opinion devotes an entire paragraph to mention of its:
Forbearance agreements with creditors,
inability to secure adequate alternative financing,
recurring operating losses,
net capital deficiency,
need for additional capital, and
questionable ability to remain a going concern...
as Zynex’s audit opinion does, many investors will tend to avoid its stock (or greatly discount the stock’s value).
In cases like Zynex’s, however, audit opinions may become stale. Though publicly traded companies typically provide financial statements on a quarterly basis, only year-end statements are audited in most cases.
Zynex’s most recent audit opinion covered statements for calendar 2016. As of that year-end, the company had posted only two consecutive profitable quarters. Moreover, it was in default on a multi-million-dollar credit line.
The litany of concerns listed by its auditors all arose from one root cause - Zynex had been losing a lot of money for a long time and had yet to satisfactorily demonstrate its profitability on a sustainable basis.
By August 2017, though, Zynex had booked four consecutive profitable quarters, cured the default by repaying its credit line borrowings in full, and was guiding toward growing profitability for the quarter now in progress. Though the company still had a negative book value of roughly $1.5 million as of June 30, this is likely to be erased by Q3-17 earnings.
But until 2018, it will have to live with the stigma of a qualified audit opinion - because the auditors won’t be back until it’s time to examine 2017’s year-end financial statements.
Speaking as an investor, I see this as bullish for the stock. Other things being equal, I believe that the stigma from Zynex’s lean years will fade over time and this will be reflected in its stock price.
Zynex’s core business is in the enviable position of being able to grow rapidly without liquidity constraints - primarily due to a business model that features:
Outsourcing of device production,
prompt monetization of receivables, and
very high gross and operating margins.
As its balance sheet indicates, its investment in fixed assets is minimal and, in fact, decreased as the company grew during 2017 - and this was also the case with its accounts receivable balance. Also alleviating liquidity concerns, its Q2-17 income statement shows a gross margin of roughly 80% and SG&A expenses that actually declined by over 15% YOY while revenues were increasing more than 50%. Notably, this decline in SG&A expenses coincided with significant expansion of salesforce headcount.
As is the case with any company in the healthcare business, there’s always a chance of some catastrophic event coming out of nowhere - perhaps a change in insurer reimbursement policies or adverse legislative developments. But this would appear unlikely, given the relatively low cost of electrotherapy and its status as an opioid alternative. In the absence of new competitors and/or products taking the electrotherapy business by storm, it’s hard to see how any vestige of the auditors’ previous going concern issues would have a place in their next opinion.
Financial Performance and Guidance
Zynex’s Q2-17 EPS of $.05 appears sustainable and, based on management guidance, is likely to grow. The quality of recently reported earnings is very strong in that there were no contributions from significant non-recurring events. Though future earnings are subject to a variety of risks, none would seem to pose imminent threats at present.
If the $.05 quarterly figure is annualized to $.20, the company’s forward P/E is just 5.5 at its current $1.10 stock price. Company guidance for Q3-17, however, calls for EBITDA in a range of $2-2.4 million. The $2.2 million midpoint represents a 10% increase from Q2-17’s $2 million figure.
Were Q3-17 to hit the midpoint of EBITDA guidance, annualizing the implied EPS would get us to a P/E of 5. Consider too that increases in income from EBITDA growth will be augmented by interest expense reductions arising from repayment of the company’s credit line at the end of Q2-17.
It was noted on this week’s conference call that Q3 tends to face headwinds as a result of doctors vacationing in July and August. Therefore, guidance implying a 10% increase in EBITDA would actually represent growth in excess of 10% on a seasonally adjusted basis. Compounding that growth for four quarters would bring us to a Q2-18 EBITDA growth figure close to 50% on a YOY basis.
I believe that Zynex’s past and projected growth merit a premium P/E multiple. Q2-17 revenues and income grew 53.2% and 769%, respectively, YOY. And in addition to exhibiting solid EBITDA growth in Q3-17, Zynex is expecting a sequential revenue increase between 8% and 16%.
At this moment, the Russell 2000 Index has a P/E of about 25, and there aren’t many of its constituent stocks with growth rates superior to Zynex’s.
To facilitate an apples-to-apples comparison, one must consider that Zynex will be paying a much higher tax rate after its loss carryforward is used up. Let’s assume that this rate will be 33% and raise the company’s P/E from 5x to 7.5x. Even without according it a premium P/E multiple, this analysis suggests that its stock is undervalued by roughly 70% - implying a fair value of $3.67.
Overview Of Prospects For Future Growth
Zynex’s future growth will be driven by:
Sales to Empi’s former customers, facilitated by recruitment of former Empi salespeople,
increasing demand for electrotherapy as a pain management tool, especially as an alternative to opioids, and
development of new products, such as the Blood Volume Monitor.
Benefiting From Empi Closure
According to a 10Q filed by Zynex on 11/14/16:
"During the fourth quarter of 2015, the electrotherapy industry experienced a significant development when the Company's largest competitor (DJO/Empi) announced the closure of their Empi electrotherapy division. Empi previously held a large share of the electrotherapy market. Management believes this presents a significant growth opportunity for the Company. The Company has recruited many former Empi sales representatives, including those in areas where it had no previous representation. In addition, during 2016, the Company's orders have been steadily increasing as compared to 2015. To focus on growth and the potential for future positive cash flow, the Company has committed its limited resources to the new salesforce, including the supporting product production and supporting administrative (customer service and billing) personnel…Through September 30, 2016, we have recruited and retained over 70 former Empi sales representatives."
In a conference call this week, Zynex’s CEO estimated that Empi’s closure created a $250 million void in the marketplace that the company is in a position to fill. The company is continuing its effort to attract former Empi sales representatives.
Increasing Demand For Electrotherapy
The global market for electrotherapy is expected to experience compounded annual growth of 4.2% through 2023, with pain management applications being a major driver of this growth.
Need for safe, non-addictive means of pain management is especially acute in the U.S., due to its epidemic of opioid abuse. Moreover, growing concerns regarding healthcare costs have led to increasing interest in relatively inexpensive treatment options, such as electrotherapy.
Zynex’s Blood Volume Monitor (ZBVM)
Currently, the most commonly used non-invasive method for detecting internal bleeding is “visual estimation,” which basically entails a medical professional eyeballing the patient. This method tends to be as inaccurate as it sounds.
The ZBVM monitors five variables linked to internal bleeding and has been shown to be substantially more accurate than visual estimation. Based on an algorithm that interprets readings from sensors applied to patients' skin, the ZBVM considers real time changes associated with blood loss:
Reduced bioimpedance (i.e. the body’s ability to conduct electricity - water being a better conductor than fat),
increased heart rate,
decreased peripheral blood flow,
decreased skin temperature, and
increased skin humidity (i.e. clamminess).
In one particularly compelling trial, the ZBVN was used to monitor eight adults while donating blood. In all cases, it successfully detected the loss of blood during the course of the donations.
The ZBVN can be useful in:
Detecting the need for transfusions,
discerning the proper amount of blood to be transfused,
providing an economical and more effective alternative to visual monitoring of post-operative patients by hospital staff, and
cutting costs by reducing recovery times.
The product is currently being reviewed by the FDA. Despite the obvious need for a tool with ZBVN’s capabilities, revenues from its sale and use are not expected for at least a year.
Conclusion
Given the magnitude of the healthcare needs being addressed by Zynex, as well as the company’s proven ability to do so profitably, its sub-$40 million market cap is unreasonably low.
Based on its revenue and earnings histories, as well as current guidance, a $3.67 stock price (implying a market cap of roughly $120 million) would be appropriate.
