Meridian Bioscience Terminably Boring
Board: Value Hounds
No one should mistake Meridian Bioscience for a great investment opportunity capable of huge portfolio gains and the best investment opportunity of a lifetime. But it may be an adequate investment idea in these trying times of few bargains and record high markets.It smells a little like an opportunity and not a wet dog since the big crash in the first quarter when VIVO disappointed everyone with revenue shortfall and high spending that crunched margins. Since then Q2 has come and gone and there has been no recovery in the share price and with good reason. Meridian reported negative earnings surprises in 2 of the last 4 quarters, with an average miss of 2.1% and management lowered its outlook for fiscal 2014 in Q2. Meridian Bioscience had to slash its fiscal 2014 revenue guidance to $190–$195 million from the previous $203–$208 million.
Brief word about the business
One segment makes diagnostic test kits and supplies and is called oddly enough Diagnostics. The other much smaller business makes reagents, antibodies, antigens and proteins for bioresearch and other diagnostic companies as raw materials.
The Diagnostics segment is 77% of revenue -- products are intended to help diagnose acute medical infections (bacteria, viral, parasitic). The product portfolio includes 140 tests. Test platforms include:
1)Isothermal DNA amplification—sounds complex and it is. It’s a molecular test based on DNA and is highly sensitive. It’s Meridiea’s best hope for any growth in the coming years. The other tests are not as likely to grow and are losing ground to molecular testing. The Meridian product is called Illumigene.
2) Enzyme immunoassays detect proteins found on bacteria, viruses etc. by using enzymes as the indicator.
Molecular diagnostics is about the only catalyst for growth at Meridian. The rise of molecular biology has revolutionized the diagnosis and treatment of diseases. Modern test methods, based on the detection of DNA and RNA, offer advantages over traditional methods for the detection of diseases. The new procedures can detect viruses, bacteria and genetic variations faster and more accurately. Treatments can be tailored better to individual patients.
It’s still a small part of revenue and Meridian offers a limited portfolio, but it’s growing fast and VIVO is adding more tests in 2014/2015 for distribution to a growing customer base. With the share price near the 52-week low and closing in on 5-year lows ($16), the 4% dividend yield makes it interesting as a stock that pays you to take a chance on growth that has an identifiable catalyst. The dividend was increased to 80¢ after no increases for three years. The increase appears to be sustainable and management has a history of paying out enough but not more than they can afford to pay from cash flow most years.
Why does the market hate Meridian?
The company has had two quarters of missed earnings, capped off by downward revision of guidance in Q2 (Q2 ended in March—year end is September). In Q2 revenue growth was 6% after a negative growth in Q1 of (1)%. Q1 was hit by a slow influenza season and delayed shipments and orders. Q2 saw a rebound but the negative guidance dampened any enthusiasm for the stock and they continued to drop.
The immunoassay test sales are definitely slowing and there is competition willing to fight for market share with pricing. Meridian as a tiny company can’t compete effectively. Illumigene also competes with companies like Cepheid but their particular platform has an expanding fan base and increasing sales and compares favorably (specificity and sensitivity) with competition. They have 5 tests approved with three more coming next year—catalyst for growth. Illumigene revenue grew 15% in Q1 and 23% in Q2.
1. illumigene® C. difficile – commercialized in August 2010
2. illumigene® Group B Streptococcus (Group B Strep or GBS) – commercialized in December 2011
3. illumigene® Group A Streptococcus (Group A Strep) – commercialized in September 2012
4. illumigene® Mycoplasma (M. pneumonia; walking pneumonia) – commercialized in June 2013
5. illumigene® Bordetella pertussis (whooping cough) – expected fiscal 2014
6. illumigene® Chlamydia trachomatis – expected fiscal 2015
7. illumigene® Neisseria gonorrhea – expected fiscal 2015
8. illumigene® Herpes Simplex Virus I & II – expected fiscal 2015
Q1 2014 was a low point with significant improvement in Q2. Illumigene revenues grew by 23% reaching nearly $10 million in sales for the quarter with double-digit increases in both illumigene Group A and illumigene Group B sales. Illumigene C. difficile revenues also improved both quarter versus quarter and sequentially. The C. Dificile test is an important product that creates much of the molecular growth.
Slowing revenue in the first half of 2014 is due to decreased momentum in hospital-associated infections:
• reduced rates of infection,
• lower hospital admission rates
• pricing pressure from increased competition
On March 25, 2014, they received FDA approval for the illumigene Pertussis (whooping cough) test. The market demand for the assay is strong and Meridian continued to increase the customer base for their molecular diagnostic products. They gained 36 accounts after the clearance and have a total base of 1,235 illuminogene customers, up from the 1,203 in Q1.
Diagnostic test for foodborne sales were flat for the second consecutive quarter due to competition and influenza revenues were off by 18%.
Life Sciences business rebounded 20% in Q2 with the core unit gaining 24% as orders that had been postponed in the first quarter were submitted and filled. Since the first half fell far short of previous guidance the company was forced to guide down substantially cementing their place as a market pariah in 2014.
Management expects 2014 net sales to be in the range of $190 million to $195 million and per share diluted earnings to be between $0.85 and $0.90. Previous guidance called for net sales of $203 million to $208 million and EPS between $0.98 and $1.03. The per share estimates assume an increase in average diluted shares outstanding from approximately 41.9 million in 2013 to approximately 42.3 million. At the high-end revenue growth is only 3% and at the low end it’s flat. Considering over the past three years Meridian has a CAGR of 8%, this is disappointing guidance. I wouldn’t expect the share price to do anything good unless they manage to surpass guidance--meeting it is not going to suffice. With a 4% yield, the stock could be accumulated slowly knowing better prices might be just around the next quarter if they fail to meet guidance again. We have Q3 results.
With 15% Q1 growth, 23% in Q2, and 3 new tests coming in 2015, there should be better news on the earnings front in a few quarters.
Annual growth and margins
Annual growth has been a fairly steady and CAGR over three years is 8% according to the company. In six years, they managed double-digit growth in two of those years. If molecular gains traction they may exceed 8% growth at some point. The 2013 margins were some of the highest in four years. That makes Q1 2014 an even bigger disappointment with some of the worst margins in years. There was convincing recovery in Q2 that failed to impress the market. Meridian’s share price is not recovering. In light of the Q2 improvement and the habitual steady performance over years, the sell off and failure to recover may be overdone.
There is little point in buying a slow growth story for the dividend if the company can’t continue to pay it. The eight-year history shows a consistent dividend increase and no missed years.
For three years 2011-2913, there were no increases. It was raised to 20¢ in the second quarter to 80¢ per year. At the current price the yield is 3.9%. A big plus is the company is debt free and has been for years. and there will be no large principal payments coming due to knock out the dividend. Capex needs are small and most of their growth is organic and the result of spending on R&D. R&D seems to hang in there at around 6% of revenue over the years. That 6% has been good for roughly 8% in revenue growth recently. Meridian has made acquisitions over the years—none recently-- and comments that acquisitions are still on the table going forward.
The dividend has exceeded FCF in two years over the past eight and in those instances there was enough cash to pay the difference with a subsequent decrease in their cash account. It never came to issuing debt. The biggest shortfall of cash flow to pay dividends was in 2011 when Meridian made a sizable acquisition. The ratios of dividend/free cash flow are 76% to 91% as Meridian pays out most of the cash flow to investors keeping the rest in the company. They have paid a sustainable ratio over the years without underspending on growth. The R&D has remained stable and they have made acquisitions. Management knows what they can afford if the track record is any indication.
Meridian has had no debt over the years included and the cost of capital is cost of equity. This is a low risk business with a solid history of good but not spectacular growth and conservative management. I would put cost of equity at 9%-11%. Whichever it is, returns are at least double the cost of capital and a solid positive spread. IMO this is returning value to shareholders even though the price has fallen and it can’t get up. It will never be flashy like Valeant but it’s a million times better managed. We can’t expect the exhilarating growth that pops price per share into Spiffyville, but I don’t think investors will be big losers at the current price. And there’s the dividend as consolation for slow growth.