Invacare Corp.: This Medical Equipment Player Can Be An Interesting Short

| About: Invacare Corporation (IVC)

Summary

Invacare Corp. is an Ohio-based manufacturer and distributor of medical equipment for non-acute care settings, particularly congenital, acquired, and degenerative ailments.

The company has been loss-making for many years and the management is raising more and more debt while trying to cut costs and push high-margin products to turn profitable.

Our assessment of the company's current situation and the fundamentals indicate that the stock is overvalued and could be an excellent candidate for a short position.

There are some companies which are consistently destroying value and incurring losses for many years, but which continue to be in the investor's portfolio on account of only one factor - hope. Invacare Corp. (IVC) is an example of one such company which has been recently driven close to its 52-week high purely on the basis of high investor expectations after a mediocre result with respect to the long-term transformational plan of the management.

However, the IVC stock continues to be range-bound. Our evaluation of the company's fundamentals and our technical analysis of the stock indicate that IVC is overvalued and it might slip back to its earlier support levels. It is possible for traders to capitalize on this fall with a minimum return of around 11% through a short position for a duration of 2-3 months.

Company Overview

IVC is involved in the fabrication and distribution of medical equipment with respect to the non-acute care settings. Its product range includes the sale of lifestyle products, mobility and seating products (e.g. power wheelchair, manual wheelchair, crutches, walkers, and positioning cushions), respiratory therapy products (e.g. portable oxygen concentrators), medical equipment, healthcare furnishings, and accessory products. The main client base of IVC for these products includes home medical equipment providers, residential living operators, distributors, and government health services. The company has its headquarters in Elyria, Ohio but has its largest portion of revenues from the European market.

IVC Is Driven By Hope And Not Fundamentals

The big question is that why did IVC's stock appreciate if the company has been loss-making for years and is also witnessing revenue dips? The answer lies in the results of the previous quarter. While IVC's results were far from great, the only point in favor of the company was that they were not as bad as the corresponding quarter of the previous year. This resulted in increasing the hope and expectations of investors, adding to the positive sentiment and pushing the stock price up to a new high.

IVC reported a quarterly revenue of $237.06 million which was a marginal increase of 2.3% over the corresponding quarter of 2017. However, this increase was purely the result of forex benefits as there was a drop of 4.4% in the constant currency sales.

There was no improvement in gross margin which remained at 28.1% and the EBITDA was slightly better than the previous quarter but mainly because the management carried out retrenchments to reduce employee costs and other selling expenses. The net loss per share improved from -$0.47 to -$0.35 and there was a marginal improvement in the cash flows.

The only segment in which IVC has been doing well is the mobility and seating products. This segment is witnessing a marginally higher demand and is one of the few segments which grew on a constant currency basis. The respiratory and lifestyle products, case goods, bed products, and interior design projects have been pulling down the top-line of the company for the previous quarter. The management talks about making investments in its transformation plan through pushing higher margin products, reducing the sales force, and refocusing resources towards more profitable activities in order to turn profitable while sacrificing sales. However, the execution of this plan seems painfully slow and it is highly unlikely that the results will be visible in the stock price of IVC in the short term.

Source: IVC

As we see in the extract above, the cash flow situation of the company has been very poor. With the one exception of the last quarter of 2017, the cash flow from operations has been consistently negative. Also, the company is required to invest a certain amount in CapEx from time to time to keep the business going, so the cash flow from investing activities is always going to be negative.

The big question here is that how does it finance all these cash losses? If we analyze the balance sheet of IVC, we realize that the level of long-term debt has risen significantly, making the company highly levered. The management also spoke about higher interest expenses in the previous quarter as a result of the issuance of more convertible notes in the last year. The problem with raising so much debt is that it significantly weakens the balance sheet and the fact that most of the debt is convertible, implies that the equity shareholders' value will diminish significantly in the future when the debt is converted.

Source: IVC/ Finviz

The extract below gives a good indication of the company's weak fundamentals and the poor performance. First of all, we clearly see that the sales growth for the past 5 years has been negative. Now, the management has claimed that the contraction in sales will be compensated by a growth in the margins and profitability, but this has not happened in the past 5 years. The company's EPS fell by 80.7% this year and it is functioning on a negative operating margin of 6.6%. The performance ratios of IVC have also been abysmal with a ROE of -17.3% and a ROA of -7%.

The only positive numbers we see are the ones with reference to the future. The analyst expectations and the guidance point towards revenue growth and towards the company turning profitable eventually. There is no price to earnings ratio today as the net income is highly negative, but the forward price to earnings is as high as 66.79 and the company is trading well above the 20-day, 50-day, and 200-day moving averages.

A High Short Float Might Bring IVC Down By More Than 10%

We have used a technical analysis of the IVC stock in order to determine our target price of IVC for a short position. When we look at the candle chart below, the first observation is that the stock has been strictly range-bound for the entire year and has clearly stayed between the strong levels of support and resistance. The 52-week high of IVC is 19.2 which is a key resistance for the stock which will be very difficult to break unless the company produces a stellar quarterly result with growth and profitability.

Given the historical trends and the outlook, it doesn't seem likely that the coming results are going to lead the stock to a technical breakout. Currently, IVC is very close to its resistance and the next result is not until August. It is highly likely that the range-bound trend will continue, and the stock will slip back to its support of $16. The level of $16 is a crucial support even as per the Gann's Square of Nines indicator and this support is unlikely to be broken unless the results are poor or unless there is bad news associated with the stock. But then, why will the stock fall back to its support from the current levels? Apart from the weak fundamentals, the company also has a high short float of 30.11% which is bound to push the price down.

Source: Yahoo Finance

In order to err on the side of caution, our target price for IVC for a horizon of 2-3 months is $16.5. We believe that there is a reasonable possibility that the stock will slip close to its support although it is important for investors holding a short position to actively keep track of the news and the earnings associated with the stock.

Risks

The projected price of IVC in this article is purely based on our technical analysis and is specific to the date of the analysis i.e. 12th June 2018. We must emphasize that it is dependent on a number of factors - continued poor performance of IVC's revenues across all segments, lack of short-term boosts in profitability or windfall gains for the company, the cash losses continuing at the current rate, and so on. While we are reasonably confident of our price projection, our analysis cannot be directed to providing any assurance about the achievability of the projected price. There is a possibility that the actual price of the company's stock is different from the projected price as a result of unexpected events and circumstances e.g. a short squeeze caused by the high short float levels, a sudden rise in the sales of the high-margin lifestyle and mobility products of IVC, an acquisition of the company, changed investor perception regarding IVC and the medical equipment sector, and so on. It is important to keep an eye on the latest news associated with IVC and the latest earnings results while holding a short position on the stock.

Conclusion

IVC isn't the kind of stock that we would like to have in our portfolio as we believe in going for fundamentally strong companies driven by financials and not by investor expectations and hope. While the management is trying desperately for a turnaround, the short float of the company is too high for the stock to stay at current levels for too long.

Our short-term price target for IVC for traders with a horizon of 2-3 months is $16.5. We believe that the weak fundamentals coupled with the range-bound nature of the stock will result in IVC slipping close to its previous support. Currently, the stock trades at around $18.7 which means that a trader would have the opportunity to make a good return of more than 11% over a 2-3 months horizon.

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.