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Background
The former Quidel (now QuidelOrtho) (NASDAQ:QDEL) has been a diagnostics testing company in the areas of rapid and cardioimmunoassay, and molecular and specialized diagnostic solutions. It was put on the map in 2020 by Covid-19, which spurred sales of tests for this disease. So earnings jumped from $1.73 a share in 2019 to $18.60 a share in 2020. They “declined” to $16.43 a share in 2021. Given that QuidelOrtho earned $11.37 a share in the first quarter and an adjusted $2.12 a share in the second, we regard our 2022 earnings estimate of $17.50 a share, “splitting the difference” between 2020 and 2021, as conservative.*
Prior to 2019, Quidel was a small, fast-growing company. Without the impact of Covid-19, its share earnings path might have been $1.73, $2.60, $3.50, $5.25, and $7.00 in 2019, 2020, 2021, 2022, and 2023 respectively (the 2019 figure is historical). So the company is no stranger to fast growth, only “hyper” growth. Even if Quidel were a garden variety, rather than hyper- fast-growing company, the current price would not be outrageously high relative to the immediately preceding earnings trajectory.
Reinvestment Was the Main Risk, But This Has Now Been Defined
But we can’t just pretend that Covid-19 never happened. The reason is that that it represented a windfall of about $40 a share (versus a 2019 book value base of $13 a share, and a pro forma yearend 2022 value of $25 a share). If Quidel were able to earn $5.25 on yearend book value of $25 a share, that would represent a healthy return on equity of over 20% (compared to “astronomical” rates of return actually earned in the preceding two years). If the company can invest its $40 windfall equity at 15% (assuming the application of the law of diminishing returns), that would be an extra $6 a share in earnings, bringing the company’s normalized earnings power to over $11 a share.
The main question regarding such a newly rich company is how will it redeploy its windfall. The former Quidel showed its hand by buying Orthocare Clinical Diagnostics, a provider of diagnostic solutions, closing in May 2022. An investor may like or dislike the acquisition and its integration, but it is at least an observable, rather than hypothetical, fact. We are positive on this deal and believe that it will be accretive to the former Quidel’s earnings.
The consideration was about $6 billion, just over $2 billion in stock, just under $2 billion in cash, and $2 billion in assumed debt. The combined company is now more highly indebted than the old Quidel ever was, but the debt represents only two years of the combined company’s annual cash flows and can be repaid in three years. We believe that the current posture is an “aberration,” occasioned by the size of the opportunity, and that paying down the debt (and realizing operating synergies) represent a built in (and reasonable) reinvestment program that the old Quidel “locked itself” into.
The old Orthocare Diagnostics had sales and gross margins comparable to those of the old Quidel, so it was technically a merger of equals. The “downside” is that Orthocare was flirting with breakeven because of poor expense control, notably in selling expenses. We believe that Quidel’s historically competent management will rein these in, then use the savings to pay down debt, while maintaining the companies’ historical sales growth.
That’s the reason we believe that the combined company can double earnings to $14 a share by 2025-2026 off the pro forma $7.00 a share in 2023. (This 2023 number was based on a worst-case number that assumed NO contribution from Covid-19 and none from the old Orthocare.) But the swiftness of cost-cutting moves suggests that the combined company will earn $9-$10 a share next year with no help from Covid-19. Subsequent 15% growth (a conservative assumption given Quidel’s history) suggests that earnings could grow to perhaps $40 a share by the early 2030s. Multiply this by a 25 P/E ratio appropriate to such a high growth company, and the stock price could be $1000 a share, more than “ten times in ten years.”
Stock Risk Factors
One good thing about this stock is that the downside risks, while real, are limited relative to the upside, because it is arguably a Graham and Dodd investment. By the end of 2022, QuidelOrtho will have a book value in the mid-60s a share, which is not much below the current stock price. If, as we believe, this represents a floor, the stock is now safer than many. The old Quidel never traded below book value because it was seen as a fast grower with high returns (high teens or better) on capital and equity. Yes, the day-to-day volatility has been quite high in the past year, but this has been from much higher prices relative to a lower (but sharply rising) asset base. The relationship between price and book value has never been more favorable, even while the company’s forward-going prospects are “above average” relative to Quidel’s history, though less spectacular than in the recent past.
It is rare that the same company offers such high returns relative to the risk. We believe that the unsustainability of early 2020s earnings is too well known, and that investors are overlooking two major positives; 1) the impact of the Covid-19 induced cash windfall that allowed for the Orthocare acquisition, and 2) the combined company’s pro forma growth prospects in the absence of Covid-19. Put another way, even if actual returns are way more moderate than what we project, the low price relative to recent earnings and stock price peaks suggests many investors will find a commitment of funds here at least somewhat worthwhile.
*Earnings figures are as adjusted by Value Line, and might differ from those reported by the company, or other sources.
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