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DexCom: medium-term growth levers in place despite high valuation (NASDAQ:DXCM)

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Investment Summary

We have long been DexCom, Inc. (NASDAQ: DXCM) and believe the company has the medium-term growth levers to secure an additional 18-20% upside from its current market price. I believe the track record of DXCM high FCF drawdowns and continued return on invested capital is currently underrepresented in its stock price and the stock is expected to trade near the $103 mark. Here I have noted several positive factors in the DXCM investing debate. Net-net, I rate DXCM as a buy on a price target of $103.

Mid-Term Growth Engine – Omnipod 5

DXCM has partnered with another long in our Insulet Corporation (PODD) medical technology equity bucket [See my analysis: Insulet, Bullish Factors For Portfolio Inclusion; HB Insights July FY22 – Buy, price target $284] in the PODD Omnipod 5 Tubeless Automated Insulin Delivery System.

The Omnipod 5 AID System is the only tubeless AID system in the United States, and DXCM’s G6 CGM System is required to control it. In other words, it cannot work without the exclusive involvement of DXCM, creating a unique value proposition for investors. This is a clear differentiator for the company and reduces execution risk in its go-to-market strategy, allowing PODD to do some of the heavy lifting, while adding another stream of value to the figure. company business.

The discoveries of Sherr and his colleagues (2020) good effect shown in patients aged 6 years and older using the system and the safety data held up well. Whereas Sherr et al. (2022) demonstrated that the system produced no episodes of severe hypoglycemia or diabetic ketoacidosis, but improved all blood glucose measurements in its population of 80 children aged 2 to 6 years.

Exhibit 1. Demonstration of BGL/insulin coupling in the Omnipod 5 System with DXCM’s G6 CGM.

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Data: PODD

The system integrates with the G6 app and automatically adjusts insulin to smooth out peaks and troughs in blood sugar (“BGL”). Every 5 minutes, the system corroborates itself to automatically increase, decrease, or pause insulin delivery to maintain a target BGL zone. He does it 24/7.

The economics of the device are also quite attractive to DXCM, in that providers can prescribe the Omnipod 5 to patients with insurance coverage, and this is accessible through the pharmacy channel – actually , it is the only American insulin pump available in pharmacies. .

More recently, the system has made progress in the tween and infant segments. It received FDA approval for the system in children ages 2 to 5 with type 1 diabetes in August, and then on September 20 received CE Mark approval for the same population group. It is understood that it will be available in some countries in the middle of next year.

DXCM Mining Trends Return in Cycle

As shown in Table 2, quarterly operating profit and free cash flow (“FCF”) have been declining over the past few years. As a result, DXCM was printing the numbers seen in FY2018 at these levels, through the first quarter of FY22. However, we have now seen a return to previous earnings cycles and as a result the FCF realized returns are back to pre-pandemic highs. This is coupled with a strong FCF conversion of $81.3 million last quarter which benefited from previous investment rounds in the business.

I am pleased to see the resumption of FCF conversion and the return of FCF to pre-pandemic ranges, and this is an important part of the investment debate. Our estimates also predict that the company will generate $2.89 billion in revenue this year, calling for growth of 14.3% at the peak of the year. [discussed later]and project it to bring it down to $148 million in FCF below net income [+179% YoY]. Therefore, DXCM enters the forward-looking climate by gaining fundamental momentum and strengthening its core fundamentals.

Exhibit 2. FCF and FCF yields normalize upwards and return to pre-pandemic ranges.

  • We forecast $148 million in FY22 FCF, calling for 179% growth.
  • I estimate the upside in cash flow yields from the second quarter of FY22 will reach this level.

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Note: All figures in millions of dollars from [%]. Free cash flow calculated as [NOPAT – investments]. FCF yield calculated based on the value of the company on a twelve-month basis. All calculations are based on GAAP earnings without reconciliations. (Data: HB Insights, DXCM SEC Filings)

The company’s performance on investment trends adds to the fundamental strength seen above. As the chart below shows, by buying DXCM, we are now buying into FY22 breakeven levels, albeit at FY19’20’ market cap. We are in the pre-pandemic period and investors have discounted the growth of FCF during this period. It has printed a cumulative $595 million in FCF since the second quarter of fiscal 2018, while it has averaged a double-digit return on investment (“ROIC”) since then as well. In Q2 FY21-Q2 FY22, it achieved an average ROIC TTM of 12.5% ​​each quarter, which tells me that DXCM is compounding capital faster than the WACC hurdle of around 6.75% with its investments in Classes.

Similar trends are seen in current investments/assets, achieving a 7.4% TTM return on assets (“ROA”) over the last period. Again, these numbers are solid for the business and we buy into these growth trends at unfairly discounted multiples in my estimation.

Piece 3.

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Note: All figures are in millions of dollars or [%]. Return on invested capital and return on assets calculated as [NOPAT/invested capital and NOPAT/total assets] respectively. All calculations are based on GAAP earnings without reconciliations. (Data: HB Insights, DXCM SEC Filings)

One point I would make in the investment debate is the question of what exactly we buy in DXCM. With the obvious strengths around its intangible assets, it identifies only $28 million in net intangible assets on the balance sheet and about an additional $943 million in property, plant and equipment. However, of the company’s $5.2 billion in total assets, about 73% or $3.8 billion of that amount is in current assets, and of that amount, about $2 billion are accounted for as short-term negotiable securities. The breakdown of DXCM’s assets is shown in Appendix 4.

Exhibit 4. ST Marketable Securities Breakdown for DXCM.

  • These represent 38% of total assets.

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Data: DXCM 10-Q Q2 FY22, “Fair value measurements”, pp.18-20; see: p.19

Evaluation and conclusion

Our internal team foresees a period of substantial top line growth over the next 3 years for DXCM. We see an FCF CAGR of 67% in FY24 with the company making $696 million [$1.77/share] in FCF at that time, with equally strong earnings growth over that period. I’m happy with these numbers, but it tells me one of two things: either there are a lot of upsides that haven’t yet priced in, or investors have discounted the share based on the multiples at which it is currently trading.

Exhibit 5. DXCM Forward Estimates, Rest of FY22; then FY22-FY24

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Data: HB Insights estimates

The shares are also trading at a premium to the constituents used in this analysis, specifically at 16.8 times book value. Valuations are certainly unattractive in terms of relative value, however, it depends on the premium one would pay to access the tracking and forward-looking strengths of ROIC and FCF discussed here today. As long-term holders of DXCM, we’re happy to continue pricing the position on every pullback to range, as it has in 2022. However, I just wouldn’t say that’s based on our points. original entry before the pandemic . So for new entrants to the stock, I’m not as confident that the same math will prevail.

Current valuations certainly add downward tilt to the risk/reward calculation at this point. However, the market priced DXCM at ~38x the forward P/E, well above the peer group, suggesting that investors expect the company to outperform the company’s sector at the end of the day. line. Additionally, attributing DXCM’s 3-year average P/E of 129x to FY22 EPS estimates of $0.80 sets a price target of $103.

Table 6. Analysis of multiples and comparisons

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Data: HB Insights, Refinitiv data feeds

Net-net, there’s a lot to like about the name, and a lot that isn’t covered in this report either. The main investment debate presented here is the resilient conversion of the company’s FCF and the generous return on investment displayed on an ongoing basis. These are attractive features in the investment debate and warrant a purchase on their own. However, to balance this out, the current multiples that DXCM is trading at are not favorable for immediate entry. Anyway, DXCM, I think there are still several mid-term growth drivers to build into the title, especially the momentum from the Omnipod collaboration. I rate DXCM as a buy on a price target of $103.