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The pandemic is not completely finished, but the Street has nevertheless turned to the question of what the new normal will look like for Hologic (NASDAQ:HOLX) as high-margin COVID-19 testing fades. The pandemic left the company in an excellent position with respect to system placements, and I believe pandemic-driven placements will create a significant barrier to entry for newer systems. At the same time, normalizing procedure counts and improving component availability should help the surgical and imaging businesses.
Hologic shares are up about 10% since my last update, outperforming Abbott (ABT), Bio-Rad (BIO), bioMerieux (OTCPK:BMXXY), and Qiagen (QGEN) over that time. I expect long-term core revenue growth of around 5% to 6% from here for Hologic, but the company will have the liquidity to be more active in M&A if management can find suitable targets. I also see opportunity for higher margins from here, but the valuation anticipates a lot of this. Hologic is a good company and holding good companies at reasonable valuations can work long term, but I wouldn’t call this a screaming bargain.
COVID-19 Testing Once Again Drives The Beat
Like many other companies exposed to COVID-19 testing, Hologic has been conservative with modeling future testing revenue, but the company has continued to enjoy upside from these testing revenues.
Revenue in the fiscal fourth quarter was down 26% in constant currency terms, and down about 1% excluding COVID-19 testing revenue; revenue was about 10% better than expected, with the upside driven largely by the excess testing revenue.
Diagnostics revenue was up 11% adjusted for COVID-19 testing, with molecular diagnostics up 17% (again, adjusted), as the company benefits from strong utilization of systems placed during the pandemic. Breast Health revenue was down 16%, missing by about 1%, with Imaging down 18% on semiconductor shortages for gantry systems, while interventional sales declined almost 7%. Gyn Surgical revenue rose 9% in organic terms, beating by about 1%, with good contributions from MyoSure, Fluent, and Boulder. Skeletal health was up about 4%, beating by about 10% (but contributing only 2% to total revenue).
Gross margin declined 690bp yoy and 130bp to 62.5%, with margin now basically back around pre-pandemic norms (a little better, maybe). Adjusted operating income declined 53%, with margin down 1460bp yoy and 440bp qoq to 27.9%, about 140bp better than the average Street estimate.
The New Normal Is Coming Into View
The next fiscal year will see some significant headwinds as Hologic continues to annualize pandemic-based testing revenue. On the other hand, businesses like Breast Health will continue to benefit from normalizing procedure counts and improved semiconductor availability. Hologic has been unable to ship to demand due to shortages, but now expects to reach normalized levels before the end of 2023.
Beyond that, growth is likely to be in the 5% to 7% range on an organic basis. I’ve seen no evidence that rivals like General Electric (GE) or Siemens Healthineers (OTCPK:SMMNY) have gained meaningful share or substantially outperformed on component availability. Meanwhile, the surgical business continues to see growth opportunities for NovaSure, MyoSure, and Acessa (and supporting platforms/systems like Fluent and Bolder), though I am curious to see if growing awareness and use of Myovant’s (MYOV) Myfembree could lead to reduced need for fibroid surgery.
Hologic should enter this next phase of its corporate life cycle in good shape in its diagnostics business. Panther placements are now in the neighborhood of 3,250, or about 70% higher than before the pandemic, and as labs have gotten accustomed to the system, they’re using it more. Exiting this quarter, management noted that at least a third of its U.S. customers are running more than four assays on the system (versus about 20% pre-pandemic).
Even as pandemic-related testing declines, I don’t believe a significant number of Panther systems are going to be mothballed, returned, or resold. Labs need flex capacity and the expanded capacity offered by the “extra” Panther systems will allow them to do more infectious disease testing (a money-maker for labs), including prevention and screening testing that has previously been deprioritized due to a lack of capacity.
I also believe that the pandemic has created some lasting barriers to entry. Between Roche (OTCQX:RHHBY) and Hologic, automated MDx systems are the norm now, and the Panther offers other advantages like easier scalability, more convenient sample collection, and reduced hands-on time. With all that, manufacturers of new automated systems are going to have a high hurdle to surmount to get labs’ attention and business.
I do also see longer-term growth in point-of-care testing. While Danaher’s (DHR) Cepheid business has established an exceptionally strong business here, even they believe the market is still less than 50% penetrated – creating longer-term opportunities for Thermo Fisher (TMO) (the Accula) and eventually Hologic’s Novodiag system.
The Outlook
Whether the 5% to 7% organic growth that management believes it can maintain over the long term is enough remains to be seen; Wall Street isn’t exactly patient or measured when it comes to its appetite for growth. Likewise, I do think the Street may look at Hologic’s long-term margin expansion potential as more limited relative to other names in the med-tech space.
I do see potential upside in the diagnostics business from an expanded Panther testing menu and Novodiag growth, but I do wonder if Street growth expectations will force the company to look for more M&A targets to drive future growth. There are adjacencies in diagnostics, breast health, and surgical tools that could offer targets, but I would hope that the company doesn’t get aggressive in pursuing entirely new verticals outside of its core marketing coverage.
I’m expecting long-term adjusted revenue growth in the neighborhood of 5% to 6%, and there could certainly be upside from any meaningful M&A. I do also expect some improvement in core free cash flow margins over time, but the company won’t be able to recapture the 40% margins that it achieved during the pandemic.
The Bottom Line
Between discounted cash flow and margin-driven EV/revenue approaches, I think Hologic is more or less fairly valued today, with long-term total annualized return potential around 8% and near-term upside to around the $80 level. I see opportunities for diagnostics to outperform (particularly with Novodiag) and Hologic will have the cash to invest in M&A, but I don’t see tremendous underappreciated growth here. All of that said, there are worse things than owning reasonably-priced shares of good companies, and I think Hologic qualifies even if I don’t see outsized return potential from the core business.
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