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Saturday, January 28, 2023

Tactile Systems: Lymphedema, Airway Clearance Markets Attractive (TCMD)

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Investment Summary

As we continue to diversify our reach into the medical technology and devices spectrum, we often benchmark two competing names against each other. Whilst this would be the case for our recent long Electromed, Inc. (ELMD) and our hold call on Tactile Systems Technology, Inc. (NASDAQ:TCMD), there are notable differences between the 2.

Both ELMD and TCMD are interesting candidates for our airway clearance market exposure [you may read our thesis on ELMD here] and compete in the distribution of high frequency chest wall oscillation (“HFCWO”) therapy devices. We have opted to position against ELMD in this regard, after comparing the two. You can check out our last publication, where we held a hold rating, by clicking this link.

One key difference that keeps us constructive on TCMD is its exposure to the lymphedema treatment market. It, like many other complex disease segments, is poised for sustained geometric growth into the next decade. This could present as a growth opportunity for the right players.

You’ll see TCMD’s breakout above a long-term downtrend below, just like countless other stocks in our coverage [if you read some of our recent publications, you’ll see the same double-bottom pattern as below]. We continue to rate TCMD a hold.

Exhibit 1. TCMD breakout above key resistance levels. Can it hold this momentum?

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Data: Updata

Exhibit 2. TCMD vs. ELMD, February 2022 to date. Not too much difference between the two. But on a risk-adjusted/volatility-adjusted basis, ELMD has it in our opinion

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Data: Updata

Differentiated Lymphedema market opportunity

The company experienced strong sales in the lymphedema and airway clearance markets in the third quarter. Furthermore, as another key takeout, airway clearance products, specifically the AffloVest, generated slightly over $11mm in revenue.

Exhibit 3. TCMD Lymphedema market estimates

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Image: TCMD Q3 FY22 investor presentation

However, focusing on the former, we believe there is differentiated exposure to the segment through TCMD. Lymphedema is a medical condition that affects an estimated 10mm people in the U.S. alone. It is characterized by the build-up of fluid in the tissue, leading to swelling, usually in the arms or legs. This condition can be caused by a variety of factors, including infection, cancer, or damage to the lymph nodes. This produces a list of limiting symptoms to a patient’s physical function. Issue is, it can be complex to treat, and many current therapies have poor compliance and success rates.

Our analysis shows that the lymphedema market offers strong growth potential, with the global market for lymphedema products and services projected to reach $11.58Bn by 2028, growing at CAGR of 5.1%. TMCD believe there are ~20mm undiagnosed cases in the U.S. and this to be a $5Bn addressable market.

Speaking of the market, it includes a wide range of products, such as compression garments, lymphatic drainage devices, and other medical equipment, as well as services related to the management of lymphedema. We believe that this market presents a unique opportunity for our readers to capitalize on the increasing demand for lymphedema products and services. However, we’ve still got to tread cautiously to find the right names. As such, TCMD is on our radar here.

Exhibit 4.

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Image: TCMD Q3 FY22 investor presentation

Q3 growth at high rate of change across core portfolio

In contrast to the above, probably the key takeout from the quarter was that, on a standalone basis – assuming it had remained a separate entity in both periods – the airway clearance product line achieved growth of 139% in Q3, illustrating the rate of adoption among the respiratory DME reps the company’s teamed up with. Moreover, the company has continuously grown its top line across the past 6 years, giving weight to the predictability of future cash flows at the top line. You can see the full spread of TCMD’s revenue, core EBITDA and FCF yield in Appendix 1 located at the end of this report.

Turning to the numbers, we observed a reasonable increase in total revenue from TCMD for the quarter, clipping $65.3mm, a 24% YoY growth. This growth was hallmarked by strong sales of airway clearance products, which increased by $10.2mm. In the lymphedema space, we’d note that the launch of the ComfortEase garments was met with positive reception from both new and existing customers, particularly in the vascular segment.

In terms of total revenue by channel, the breakdown was as follows:

  • $36.2mm from commercial payers,
  • $11.3mm from Medicare,
  • $11mm from durable medical equipment distributors, and
  • $6.8mm from the VA.

These figures represent an increase from the same quarter in the previous year, “in which commercial payers, Medicare, DME distributors, and the VA contributed $36mm, $8.9mm, $861,000, and $6.7mm, respectively.”

Scrolling down the P&L, our bullish highlights were as follows:

  1. We saw some margin decompression at the top, which could be a tailwind going into Q4. Gross margin for the quarter was 71.7% of revenue, compared to 70.4% in the same quarter of the previous year. The non-GAAP gross margin, which excludes non-cash intangible amortization, increased by nearly 40bps YoY to reach 72.2% compared to 71.8% in the prior year. The increase in non-GAAP gross margin was attributed to a combination of product and payer mix.
  2. Switching to OpEx, it wasn’t surprising to see the 26% YoY increase to $48.4mm in the current environment. Thankfully, a bulk of the spend was went to toward increasing the headcount of the AffloVest and Lymphedema sales teams.
  3. Management’s revised guidance for 2022 total revenue shows growth of approximately 16%–18% YoY, with a revised outlook of $242mm to $245mm. This compares to our prior guidance range of $238mm to $242mm, which represented growth of approximately 14% to 16% YoY. It also forecasts adjusted EBITDA of ~$15mm–$16mm
  4. Note, growth assumptions include lymphedema product sales in the range of $207mm to $209mm, representing growth of 250bps at the midpoint. Airway clearance products are expected to generate sales of approximately $35mm to $36mm, compared to our prior guidance range of $30mm to $32mm. Additional upgrades are gross margins in the range of 71% to 72%, GAAP OpEx to increase 26%–28% YoY, [compared to 23%–24% previously].

Valuation and conclusion

It’s worth noting that Tactile Systems Technology, Inc. is trading at a fair valuation on face value. Question is, do the numbers represent a discount, or is it just lowly valued.

To help answer this question, we looked at a number of factors. First we checked profitability, and have seen the return on capital creep lower whilst free cash flows (“FCF”) remain in their cyclical trend. You can see the new level in the chart below.

Last time, we noted that shares were trading at 1.4x book value, and it now trades at 1.8x price/book. It also trades at 15.7x forward EBITDA, and we believe management’s forecasts for $15mm are reasonable. Applying the multiple to that forecast derives a price target of $11, not a great deal of upside to harvest.

Exhibit 5. TCMD Return on capital drifting lower despite same amount of free cash flows. Can management be investing more cash?

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Data: HBI, Refinitiv Eikon, Koyfin

In addition, our technical price targets for Tactile Systems Technology, Inc. are demonstrating upside objectives to $12.80. Whilst this is encouraging, it doesn’t demonstrate the kind of capital growth we’d be searching for at this point in time. We are still constructive on TCMD, however. It will be one kept under close inspection for the reasons mentioned throughout this report.

Hence, we retain our hold thesis on Tactile Systems Technology, Inc. for these reasons.

Exhibit 6. Upside targets to $12.80, but nothing to suggest high rate of change just yet

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Data: Updata

Appendix 1. TCMD revenue growth. The company continues to grab market shares, evidenced by its ongoing revenue upsides. This is something to factor in heavily to the risk/reward calculus

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Data: HBi, Refinitiv Eikon, Koyfin



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