KanawatTH
Introduction to Sensus
Sensus Healthcare (NASDAQ:SRTS) is a profitable, debt-free, rapidly growing, high-margin, cheaply valued medical device company focused on radiation treatment for skin cancer. I won’t be describing the business of Sensus in great detail. Other authors on Seeking Alpha have done that well. In addition, Jaguar Capital has put together an extremely thorough report on Sensus, describing its products, going through various valuation models, and even doing channel checks on its different distribution partners, and describes the company as a strong buy with a valuation of $30. I was bullish on the company’s prospects even before the recent share price decline, and now I feel the risk/reward is even more compelling.
The Runup to the Q4 Earnings Report
Sensus Healthcare experienced a rocky reception to its Q3 earnings report. The company is based in Florida, and since it is in the early innings of its national and international expansion, a large concentration of its employees and prospective customers are in Florida. So when Hurricane Ian hit, this naturally caused somewhat of a disruption to their operations, leading to a 5% miss on revenue and a two penny miss on EPS. Given that this was a one-time event, and that the company explained no permanent damage was done to its overall growth trajectory, one would assume that only a modest drop in the stock price would follow. Instead, Sensus fell by an astonishing 50% the next day. Sensus executed a well-timed stock buyback during the quarter, and eventually the share price slowly recovered.
In January, Sensus pre-announced earnings, with revenue “in excess” of $13 million, which was at the time about 7% higher than analysts had estimated. This showed that the hurricane disruption was indeed a one-time event, and Sensus was back on track, ready to close out the year strong with over 60% annual revenue growth. The stock rose from around $7 a share to nearly $9 a share – still a far cry from $14 it had traded at before Q3 earnings, but way up from the $6.35 price it had closed at after the undeserved selloff.
The Q4 Report: Numbers Actually Beat Expectations
Often, when a company pre-announces numbers, analysts do not update their earlier expectations, to allow the company to “enjoy” their beat when they make their formal announcement. But for whatever reason, this did not happen with Sensus. Analysts did indeed raise their expectations after the pre-announced numbers, so a revenue of $13.1 million became a “miss” because analysts moved their expectation of revenue up to $13.2 million. Similarly, EPS expectations were also moved up. Analysts also apparently forgot to consider that Sensus sold off an asset earlier in the year. This increased their tax liability, which they distributed evenly throughout the fiscal year. This increase of tax is responsible for the six cent EPS “miss;” without it, Sensus would have beat even the updated expectations.
And so, a report which would have been considered a modest beat before the January pre-announced became a slight miss. This sparked another frenzied panic selloff, with shares falling as much as 30% in the first few minutes in heavy volume. Over the course of the rest of the day, shares did creep back up, but the stock still finished down 20%, on a report which in all honesty probably shouldn’t have moved the stock price much at all.
The Selloff was Unjustified
Aside from the misleading revenue and EPS “miss,” there was nothing at all negative on the call. Sensus did not give specific guidance, but did say they would grow revenues in Q1 (this line was only included in the press release, not the earnings call) and grow both revenue and EPS for the full year. Sensus also promised to submit new products for FDA approval soon, expand their marketing footprint, and refrain from any dilutive or debt-heavy acquisitions.
Sensus also promised to do another share buyback if shares fall to distressed levels, which clearly has happened.
Sensus shares recovered very nicely from their unjustified Q3 selloff. If you bought shares at the end of the day following the Q3 report and sold the day before Q4, you got a nice 40% gain. Even if you held through the post-Q4 earnings collapse, you still came out with an 11% gain.
In my opinion, the collapse in Q4 is even more unjustified than in Q3 – because the hurricane was, in fact, a real (if temporary) hiccup for Sensus and it was unclear exactly how fast they would bounce back. In Q4, Sensus showed it has already bounced back, and yet shares collapsed again anyway.
Analysts are Bullish
Following the Q4 report, Marketbeat shows 3 analyst ratings, all buys and all with price targets that imply more than 100% upside: $14.50, $16, and $20.
In my opinion, it can be difficult to trust analyst targets for small cap stocks, because analysts are often employed by firms that also serve as bookrunners for equity or debt offerings for the same companies. This gives them incentives to try to move the price of the stock for the benefit of their firm, rather than their readership. However, Sensus is profitable, has no debt, has a large cash position, and has repeatedly said they will not go into debt or dilute shareholders to finance acquisitions. There is therefore little reason for analysts to be overly optimistic. And with a forward P/E of just 8.8, Sensus is hardly priced for perfection. Out of 140 stocks in the medical device sector, Sensus has the second lowest forward P/E. (In my opinion, forward P/E is the best way to value a company like Sensus, because it ignores the effect of one-time events like the asset sale Sensus had in early 2022.)
Analysts have also already revised their revenue expectations upwards for Q1. In other words, what they saw in the Q4 report made them more confident in the future, not less.
Risks
Small cap stocks always have some risk, but it does not appear that new risks have emerged since the Q3 call that would explain the selloff, with one possible exception. Sensus has described one key risk – higher interest rates. Sensus does try to encourage doctors to do debt financing to buy its devices, under the assumption that just by seeing a couple of patients a month, the machine will pay for itself. This debt financing pitch is slightly less convincing with higher interest rates, but Sensus itself has said that most of its customers do in fact pay in cash, and that it hasn’t run into any serious issues so far.
The main risk I can see is purely technical. The huge selloff has created an “ugly” chart and may cause others to panic, causing shares to drift even lower, as happened following the Q3 report. Buying Sensus below $6, however, ended up being a great investment. So while volatility may remain high and shares could drop further, I view this as a temporary problem. Similarly, the upcoming CPI numbers and FOMC events may create downwards pressure on the overall market, and those pressures could have an outsized impact on small cap stocks like Sensus. However, in a world with high interest rates, companies that are profitable, with plenty of cash and cheap valuations, like Sensus, should outperform companies that rely on debt financing to survive. Finally, while a recession might not be great for Sensus, it is certainly better positioned to weather that storm compared to other companies. After all, if you have cancer, you can’t really afford to wait to treat it.
The Bottom Line
Sensus was my largest holding going into the Q4 earnings, and I expected the solid numbers would convince everyone that the hurricane hiccup was over. Instead, the stock crashed again for no justified reason that I could find. The company does have a history of unjustly selling off – but last time, it did manage a very strong recovery. This selloff was smaller and less justified than the prior one, so it’s possible it will recover faster as well. Even if Sensus merely goes back to the price it was before the Q4 report and does nothing else, that would be a substantial gain at today’s prices. Risk-reward appears to be tilted in favor of buyers.
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