Cepheid: Maybe Not The End After All

| About: CEPHEID (CPHD)

Summary

A few weak quarters and rising concerns over competition are destabilizing the leadership position enjoyed by the company and have taken a toll on the stock.

New products, the second half ramp of placements that are already underway and improved distribution partnerships may act as positive growth catalysts.

The balance sheet is decent, which combined with the possibility of sustained profitability and positive cash flow by next year should help the business command an improved trading multiple.

Cepheid (CPHD) over the past year has traded like a matured healthcare equipment business, with a poor stock performance combined with questions being raised about the long-term competitiveness of the product portfolio and investors worrying about profitability, rather than the topline growth. There were some well-timed Short reports from prestigious research shops last year, a call that worked perfectly, which elevated investor concerns, but an earnings miss and weak competitive positioning was also to blame.

Cepheid's is by far the smallest player, others being Roche (OTCQX:RHHBY), an aggressive acquirer in the space lately, Hologic (NASDAQ:HOLX), Becton Dickinson (NYSE:BDX), Qiagen (NASDAQ:QGEN) and Abbott Labs (NYSE:ABT), and one of the pure-plays in the molecular diagnostics market, making it easier for Bears to raise doubts over increased competition down the road.

But some silver linings are visible, now that earnings visibility is back as reflected in the latest results and much of the Short thesis is priced in the stock. Improving fundamentals suggest the business might be able to maintain its current leadership position in the molecular diagnostics space, which is widely accepted even by staunchest bears, and the positive momentum on the product development and distribution fronts may position the business for a decent double-digit topline growth, with matching earnings.

With the GeneXpert system having one of the largest footprints of an installed base and a typical 'razor and razor-blade' revenue model with growing regent sales, the draw of the business model, somewhat reflected in the competition, is natural and strong. The poor momentum of last year has given way to expectations of a strong ramp from this quarter onwards, with help from new products, likes of Carba-R and Virology, and efforts to improve sales distribution are bearing results.

The balance sheet is healthy enough to not require any dilution in the near future, while the profitability should benefit from manufacturing cost reduction initiatives and an expected 300 basis points gross margin improvement by 2017, with help from new products that come out with lower cost enzymes.

Decent growth catalysts via strength in existing product offerings and hope for the future

Fundamental developments suggest the pace of improvement may pick up over the coming months, a significant change from the usual seasonal downturn during the third quarter.

Besides continued growth in existing products, given the latest quarter being a record quarter for system placements and second strongest ever for commercial system placements, the ramp of Virology products, especially in the point-of-care markets, rollout of recently won high volume accounts for CT/NG, commercial release of oncology products and second half HBDC (high burden developing country) related ramp in India do promise to act as strong growth catalysts over the coming months. In India, the 500 unit placements and remaining 500,000 tests are expected to finish during the current half, offering a nice tailwind.

Another positive catalyst can be the improved distribution infrastructure and partnerships like Henry Schein (NASDAQ:HSIC) and McKeeson (NYSE:MCK), especially in the physician-office labs and point-of-care channels, where the company has considerably low penetration.

Given the well-recognized leadership in the molecular diagnostics space, the business should be high on the list of potential acquisition candidates, but looking at the stock, the premium for the same seems missing, something improved visibility and sustained profitability might change.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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