Meridian Bioscience: Good Stock, But Margin Of Safety Required

Summary

• Meridian Bioscience benefited from a windfall due to the Covid-19 pandemic, resulting in the growth of its Life Science segment.
• There will be a market for Covid testing in the post-Covid world, but the eventual market size of Covid testing remains uncertain.
• Its Diagnostic segment is the key to watch. We need more evidence of success.
• Hence, while we believe that this small cap has potential to be a multibagger for the long term, we require a margin of safety to mitigate the risks.

Photo by sanjeri/E+ via Getty Images

Investment Thesis

Meridian Bioscience (NASDAQ:VIVO) is a fast-growing company in the medical device industry. It has demonstrated a strong profitability record of approximately 60% gross profit margin and 20% EBIT margin, achieving ROE of between 12 to 21%, over the past 5 years. In a post-Covid world, the company will continue to capture the market share in Covid testing for its Life Science segment, although the eventual market size of Covid testing remains unclear. The other open question is the company's ability to execute its growth strategies for its Diagnostic segment, which is a key growth driver for the company. Overall, we believe that this small cap stock has the potential to be a multibagger in the longer term, but we prefer a margin of safety of 20 to 40% to mitigate the stated risks.

Source: VIVO Investor Presentation

Methodology

We developed a quantitative model to rank all US small-cap stocks with market capitalization of between $200M to $2B, based on their 5-year average return on common equity (with a 30% weightage), 5-year average gross profit (30%), 5-year revenue CAGR (8%), along with other metrics such as levered free cash, EBITDA CAGR, quick ratio, interest coverage ratio, debt-to-equity, cash-to-total-capital ratio and non-free float shares. If you are interested to learn more about our methodology, quantitative model and approach, you can read more in our blog article on Search for Long Term Compounders - Our Methodology & Approach.

Source: Libertus Research, Finbox

The motivation for this quantitative scoring model was to uncover the next wave of businesses that exhibit potential in growing exponentially to be the next mid to large-cap stocks.

VIVO was ranked at #58 in a universe of more than 1,400 small-cap stocks in the NYSE and NASDAQ. Its growth score was relatively weaker but we believe that the outlook for the company has changed with the Covid pandemic.

Profitability record is strong

As we can see in Meridian's profitability metrics from Seeking Alpha below, they have a strong record. Based on their filings, they have consistently achieved gross profit margin above 60% (except for 59.1% in 2019) and EBIT margins of around 20% in the past 5 years. Its ROE was approximately 12% pre-Covid and climbed to 21.1% in 2020.

Source: Seeking Alpha

More evidence of success required in their growth execution

From our quantitative model, we know that Meridian Bioscience's growth metrics are weaker. We analyzed its growth pathways based on its two business segments - Life Science and Diagnostics.

Source: VIVO Investor Presentation

In the Life Science segment, VIVO has benefited tremendously from the tailwind due to the Covid pandemic and overwhelming demand for Covid testing. Specifically, sales of molecular reagents and immunological reagents have increased 758% and 128% respectively for FY2020. As vaccines are introduced, the demand for Covid testing will fall and stabilize at a 'new normal', but it will not be at the peak that we saw in 2020. Accordingly, the market has priced this into the company's stock price and it has fallen from its peak of ~$30. The stock price has remained volatile with successful news on vaccine successes causing price drops, while negative news on vaccine delays and extended lockdowns causing price spikes.

In a post-Covid world, we believe that there will still be a healthy residual demand for Covid testing because of the likelihood of strain mutation and uneven vaccination implementation globally. Just as the world transitioned to requiring stricter security checks at airports post-911 attacks, we would have stricter enforcement of Covid testing at border controls in time to come. This is the basis to reopening border travel successfully, with countries such as Singapore piloting the requirement of vaccine passport and Covid test results. Covid testing would still be required even when the population achieves herd immunity. However, the residual demand and eventual market size of Covid testing remains unclear. As a rule of thumb - at the risk of saying the obvious - the market size would be between what was seen pre-Covid and at the peak of Covid testing in 2020. In this regard, the performance of VIVO's Life Science segment will taper over time, and the market is efficiently pricing this into its stock price with the dips.

In the Diagnostics segment, we need more evidence of success to have greater confidence in Meridian's growth execution plan. The Revogene platform was touted to be one of the key growth priorities in 2021, but it appears to be meeting hiccups with the FDA when they withdrew their Emergency Use Authorization application for its SARS-Cov-2 molecular diagnostic test. Earlier this month, the company announced an FDA submission for its new Curian Campy assay in the gastrointestinal disease and lateral flow testing market. We would have to see if it would be accepted.

Longer term growth of Meridian Bioscience would need to come from its Diagnostics segment, and at present, it has not been forthcoming. More evidence of success is required.

Decent balance sheet

Benefiting from the windfall from the surge of demand in Covid testing, VIVO has now built up a healthy cash reserve of $63.19M, against its outstanding debt of $65.87M. Its cash reserve will continue to grow slightly as the demand for Covid testing tapers off.

Recent insider selling affects confidence

Insider transactions indicated heavy buying in 2019 and early 2020 at prices of between $7 to $18. However, the spate of insider selling between prices of $25 to $30 by senior management in 2020 and 2021 reinforced our belief that the stock price has peaked at these levels primarily due to Covid.

Source: OpenInsider

Diagnostics is a competitive space

VIVO operates in a highly competitive industry, and this risk was well spelt out in their 10K filing:

Our major competitors in molecular diagnostics are Cepheid (a Danaher business) and Becton Dickinson, both of which have systems with multiple-assay menus. We also face competition in molecular diagnostics, but to a lesser degree, from companies such as Abbott (former Alere business) and Quidel. Our major competitors in rapid immunoassay diagnostics are primarily Abbott (former Alere business) and Quidel. In recent years, companies such as bioMerieux have captured market share in our gastrointestinal category via its BioFire multiplex panel tests. However, since their introduction to the market, payors have raised concerns over reimbursement levels relative to clinical utility, particularly for panels with 12 or more targets.

For blood lead testing, we believe we have the only FDA-cleared, CLIA-waived point-of-care test available commercially. Other blood lead testing systems in use, marketed by our competitors, include Graphite Furnace Atomic Absorption Spectroscopy, which requires a highly skilled technician and larger laboratory space to operate, in addition to not being portable or suitable for point-of-care use.

Our major competitor for urea breath testing for H. pylori is Otsuka, a pharmaceutical company that also markets and sells a urea breath testing system. We believe that our BreathID system has a competitive advantage in that it: (i) has substantially higher sensitivity and specificity; (II) has a shorter processing time; (III) offers full automation; and (iv) connects directly to lab information systems. We believe that with the breadth and depth of our product portfolio, we are well positioned for the clinical laboratory.

In our opinion, it is critical that the company demonstrates success with their product and/or service offerings in the Diagnostic segment. Otherwise, there would be no upside for the stock as the vaccination efforts ramp up across the world.

Valuation

Based on a comparison with its peer group, VIVO is relatively overpriced compared to its closest peer, Quidel (QDEL). Its other competitors, Abbott Laboratories and Becton, Dickinson and Company, enjoy relatively richer valuation but they are behemoths with far more business products and services.

In view of our analysis above, we believe that VIVO is fairly priced today at ~$25 but we would prefer to have a 20 to 40% margin of safety due to open questions on growth execution and the issues of insider selling. We are placing VIVO on our watchlist and intend to initiate buying at a price range of between $15 to $20, especially if there is volatility or news of vaccine implementation successes.

Source: Seeking Alpha

Conclusion

Meridian Bioscience has potential to be a multibagger and it has a good track record of profitability. What we now require is more evidence of success in their growth execution, particularly in the Diagnostics segment. We are therefore putting this stock on our watchlist, with a preferred margin of safety of 20 to 40% to hold it in our long term portfolio.

Analyst’s 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.