Tandem Diabetes Care Is A Strong Buy (NASDAQ:TNDM)

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In the last nine months, I have witnessed a growing number of extreme reactions by the market in response to company financial reports. Growth stocks are among those hit hardest from this influx in market volatility because of macroeconomic pressures. A prime example of the market’s volatility is Tandem Diabetes Care (NASDAQ:TNDM), a security that has had a sharp downturn since the beginning of the year. Tandem Diabetes Care is a strong buy because of its low valuation despite continued revenue growth, widening of margins, and a growing customer base.

Company Background

Founded in 2006 and headquartered in San Diego, Calif., Tandem Diabetes Care is a medical device company specializing in products for those with insulin-dependent diabetes in the United States and internationally. Their flagship product is an insulin delivery system, comprised of an insulin pump, a disposable insulin cartridge, and an infusion set. This system uses a computerized device to deliver pre-determined amounts of insulin to diabetics. Tandem Diabetes Care also provides a software program called t:connect, which acts as a web-based data management system, and Sugarmate, a mobile app for those with diabetes who use insulin.

Tandem Diabetes Care holds approximately a roughly 30% market share of the global insulin pump industry. Of their worldwide sales, insulin pumps make up ~54%, infusion sets 26.5%, and cartridges 14%. The industry is projected to grow at a CAGR of 16.3% for the next decade, driven by the sharp increase in type 1 diabetics. Major competitors in this industry include Abiomed (ABMD), DexCom (DXCM), and Insulet (PODD).

Financial Overview

For the first quarter of 2022, the company generated $175 million in revenue (24.7% YoY) which exceeded consensus. However, EPS had an approximately -225% surprise and grossly underperformed expectations. These mixed financials coupled with a similar (but less drastic) missed earnings from Q4 2021 and the overall market downturn has put Tandem Diabetes Care down 59% year to date from $150.09 (as of the June 24, 2022, market close).

The company calculated an operating loss of $15.3 million compared to $3.2 million this quarter last year. However, this is not due to an increase in cost of goods sold or SG&A expenses, but from a rapid increase in R&D. Tandem Diabetes Care had an ~85% increase in R&D spending compared to Q1 2021 which is reflective of a conscious trend made by management. This includes undertaking the largest human factor studies in company history and production of the Mobi, a novel, miniaturized pump that will be fully controlled through their mobile application. Assuming this is a one-off cost and R&D will return to normal levels next year, Tandem Diabetes Care actually operated at a profit with an income of $139 million.

Tandem Diabetes Care currently has 64 million shares outstanding and a market capitalization of $3.935 billion. It has $635.39 million in cash equivalents and $419.18 of debt for net cash of $216.21 million. Thus, I calculate an enterprise value of roughly $3.72 billion.

Valuation: Fair Value of $132 Per Share

The company has guided sales to be in the range of $850 million to $865 million, which represents an annual sales growth of 21% to 23% compared to 2021 ($635-$645 million from the U.S.). Assuming a middle-of-the-road actual sales number, 2022 annual revenue will be $858 million – a 22% increase YoY. To value Tandem Diabetes Care compared to its competitors, we will use a price/forward sales ratio since most companies within the insulin pump industry tend to be lightly profitable. Price/forward sales is calculated by dividing the market cap by the projected 2022 revenue. With a market capitalization of $3.935 billion and 2022 revenue of $858 million, this yields a price/forward sales ratio of 4.6x.

Applying this same valuation methodology to Abiomed, DexCom, and Insulet (using middle-of-the-road 2022 revenues based on company guidance) yields far higher price/forward sales ratios. Abiomed has a market cap of $11.558 billion and projected sales of $1.027 billion (22% growth YoY). This gives them a price/forward sales ratio of 11.3x. DexCom has a market cap of $30.470 billion, projected sales of $2.88 billion (18% growth YoY), and a price/forward sales ratio of 10.6x. Insulet has a market cap of $15.07 billion, projected sales of $1.253 billion (14% growth YoY), and a price/forward sales ratio of 12x. (You can find more details in this downloadable file.)

With estimated revenue growth of 21%, I believe the market has placed Tandem Diabetes Care at an excessive discount, especially when compared to its peers. It continues to expand revenue and market share while operating at profit (assuming R&D is a one-off increase). A more fair market price would be at a price/forward sales ratio more similar to its peers – I believe this is 9.5x. Using this valuation, the equity would have a market cap of $8.151 billion and a price of $127. Thus, I believe that this security has a true value of $127. Dividing the price target by its share price of $61.52, subtracting one, and multiplying by 100 shows this is a 107% increase from its current market price.

I believe that there is a 107% upside from the current (as of June 24, 2022, close) $61.52 share price and recommend that investors with a balanced portfolio take a long position in the equity. The market has placed an overly reactionary discount based on a misreading of recent earnings combined with recessionary fears. The continued earnings per share surprise was not due a decrease in sales, but because of increased research and development and macroeconomic pressures.

I see further positive signs in future revenues from the details of Q1 reports. U.S. revenue was driven higher by larger-than-expected pump revenue. These pumps grew 12% year-over-year despite the impact of Omicron. Most of this increase came from diabetics formerly using multiple daily injections, but also from renewals (44% increase year-over-year). This will result in a new wave of users up for renewals in late 2022 and into 2023. Additionally, gross profit stayed in line from Q1 2021, despite increased freight costs from global supply chain pressure. This is from the companies decrease in price per unit produced and increase in average selling prices. This shows Tandem Diabetes Care’s widening of profit margins.

Risks Moderated by Discounted Valuation

Like any growth stock, a long position in Tandem Diabetes Care requires many things to go right to justify the premium paid now. However, this risk is mitigated by the discounted valuation this company has relative to others in the sector. An investor can further limit their exposure by purchasing put options on the security if it continues to decline in price.

Due to fears of a looming recession and further increase rate hikes by the Fed, this equity might continue to decline with the rest of the market. However, Tandem Diabetes Care’s demonstrated ability to grow revenue and improve margins despite increasing macroeconomic pressures show its ability to thrive under any economic situation.

Conclusion

Tandem Diabetes Care continues to grow and capture market share in a rapidly expanding market. Consistent annual revenue and operating margin expansion coupled with a strong increase in renewed purchases are signs of an expanding organization, but the company has been overly penalized for mixed Q4 2021 and Q1 2022 earnings. Due to this penalization and the bear market, the security has become undervalued by 55%. With a price/forward sales ratio more similar to its high growth peers, it has a fair market price of ~$132.