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Friday, January 27, 2023

Mesa Labs: Breakout Noted, Looks Exhausted On Closer Inspection

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Investment Summary

As the market continues to roll on hard into the final stages of FY22 a number of small-cap names have bounced from multi-period lows over the past month. One such name in our universe, amongst many, is Mesa Laboratories, Inc. (NASDAQ:MLAB), a name we’d extensively reviewed back in September. If you didn’t already know, our hold thesis was built around these major points:

  1. Return on investment (“ROIC”) continues to tighten for MLAB despite the level of invested capital lifting sequentially.
  2. This presented as a downside risk looking ahead. With a “weakening economic outlook, positioning against companies generating cash from investments made above the cost of capital is paramount”. MLAB missed the hurdle here.
  3. Valuations are equally as unsuppportive.

After we saw that MLAB broke out above a 10-month downtrend and held the trend for 4 weeks, we were compelled to revisit the position. Noting its Q2 FY23 (Q3 FY22 from hereon in) numbers, and recent market data, we’re here to reiterate our negative points on MLAB. Therein lies a clear decision to hold on investing on our end, with more conviction elsewhere in the space. Rate hold.

Exhibit 1. MLAB breakout above 10-month downtrend (weekly bars)

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Note: Log scale (Data: Updata)

Fundamental momentum balanced throughout Q3 results

Turning to our review of the 10-Q, we noted that revenue pulled in to $58.75mm, a YoY growth of 71.9% and ahead of consensus by $5.27mm. It pulled this down to GAAP EPS of $0.24 beating the Street by $0.55.

Notable takeouts from the period were centered around the company’s portfolio segments. To name a few:

  1. We saw the clinical genomics division book revenues of $18.43mm, up 27% YoY. After being impacted by the Chinese government’s shutdowns and restrictions in response to the COVID-19 pandemic, revenues in the division returned to a more typical level in the quarter. Of the reported revenues, $179,000 can be attributed to COVID-19 related sales.
  2. In addition, sterilization and disinfection control revenues increased by 21% YoY, despite a significant strengthening of the USD/EUR.
  3. It also beefed up its workforce, adding to its temporary and permanent manufacturing headcount at its Bozeman, Montana facility. The pull-through of this enabled it to fulfill a higher volume of customer orders than in the previous period, which is a notable tailwind. Management noted that it’s still possible that it will experience labor shortages in the future, which could impact its gross profits.

Exhibit 1 provides the longer history of MLAB’s operating performance. Another factor that balances the investment debate is the relatively stable trailing FCF yield.

Exhibit 1. MLAB Revenue, core EBITDA, and trailing FCF yield

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Data: HBI, Refinitiv Eikon, Koyfin

As to further, divisional highlights, we found additional takeouts in MLAB’s biopharmaceutical development segment.

As a reminder, the biopharmaceutical development division focuses on the production and sale of automated systems for protein analysis (immunoassays) and peptide synthesis solutions. These products expedite the discovery, development, and manufacturing of biotherapeutic drugs.

Biopharmaceutical development revenues increased by 15%, while gross profit decreased by one percentage point. CFFO has provided $7.74mm this YTTD, whereas net loss totaled $22,76mm for the same period. We also noted that from working capital ~$10mm more cash was tied up in the cash conversion cycle, as the company noted due to “decreased collections on trade receivables and increased inventory spend to mitigate supply chain risk”. It also repaid $22mm on its credit facility during the past 2 quarters.

Technicals not yet supportive of entry either

Looking deeper at the market’s positioning in the stock, we see there’s a divergence from key upside drivers.

MLAB currently trades below cloud support, with on-balance volume and momentum dragging as well. The cloud is also red and widening, with a lack of buying support in our opinion.

Exhibit 2. Trading below cloud support, on balance volume and momentum dragging = lack of buyers?

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Data: Updata

This is confirmed on our technical indicators with downside targets to $134, as you can see below. Moreover, there’s been no breakout above resistance in this study. This is on a daily study, so we are looking to forecast what is potentially happening in the coming weeks.

Exhibit 3. Downside targets to $134

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Data: Updata

Valuation and conclusion

Unfortunately, valuations remain equally as unsupportive in this case. Last time, we noted that, “[s]hares are trading at 30x TTM EV/EBITDA and are priced at 4.2x sales, a premium and discount to the GICS health care peer group respectively. Shares also appear to be richly priced as 32x cash flow and 2.2x book value”. Question is, at 20x forward EBITDA, is it still richly priced?

Our forecasts from last time remain unchanged and rolling our FY23’s core EBITDA number of $46mm forward at the 20x multiple derives a valuation of $172, and thus no upside potential. This would confirm our neutral viewpoint as well.

Hence, we’ve not seen enough evidence to change our original position on the stock. Nonetheless, it is had caught a strong bid in recent terms, and this updated note should help guide investors’ reasoning in any positioning each way. Without a directional view of the market, we rate neutral.



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