Irina Shatilova/iStock via Getty Images

Irina Shatilova/iStock via Getty Images

OraSure Technologies, Inc. (NASDAQ:OSUR ) is best known for providing the saliva DNA sample collection kit that's used by DNA/ancestry testing company 23andMe. The company has benefited from COVID-19 related tailwinds in its diagnostic solutions segment, and has made a recent acquisition of DNA Genotek Inc., whilst also delivering decent sales growth in its most recent filing.

Exhibit 1. OSUR 12-month price action

However, the company has its tentacles wrapped around a number of testing and diagnostic segments, but has yet to prove itself within these new markets. Execution risk is therefore paramount in the OSUR investment debate. This, coupled with below industry profitability metrics, and trailing free cash flow/earnings yields that are less than exciting, leaves us relatively unconstructive on this name. We don't see profitability in free cash flow until FY23 for OSUR, and we also see a lumpy period of sales growth in the coming 5 year period. A lack of valuation premium/expansion over the previous years alongside these factors has us neutral on the stock. Trading at $2.99 on last check, we see multiple downside targets to be met at the $2.22-$2.42 range, pricing the stock at $2.54 per share on an equal-weight valuation composite. Our findings suggest there is a lack of upside potential to be realized in the near-to-medium term, unless the narrative changes.

Turning to the most recent quarter, the company reported Q1 FY22 sales volume of $67.7 million, a 16% year-on-year growth schedule that came in above the street. Growth was underscored by InteliSwab Covid antigen test sales of ~$22 million, with the bulk of turnover attributed to the government contract. The company was able to scale up production last quarter, per management, although it did not provide specific numbers. Our analysis saw diagnostic testing (minus the Intel swab segment) grow 11% year on year to just over $16 million, underlined by international HIV segment sales that grew 20% year on year. Offsetting these strengths, Domestic HIV sales recognized an approximate 30% decline year-on-year.

Molecular solutions continues to be a highlight for the company, growing $29 million over the year. This was spearheaded by a ~40% growth schedule in genomics, with most of this stemming from the commercial segment. The fact genetic risk testing restarted throughout the quarter was a bonus. In addition, the Microbiome division widened by 14%. Noteworthy is that the number of Covid collection kits resulted in a decline to lab services turnover of ~30% year on year. A key risk factor in this debate is that OSUR printed a gross margin of just 35.8% in the last quarter - well below Q1FY21 gross margin of 65.4% and the Q4FY21 result of 43%. This softening of margins is set to impact the P&L into the coming years, and we envision a down step in EPS from -$0.14 to -$0.13 in the upcoming quarter, sinking to -$0.06 by Q3 FY22. This accumulates to FY22 EPS of -$0.44 in our model. Note that this is well below FY21 actuals of -$0.34 and FY19 (pre-pandemic) EPS of +$0.13.

Data & Image: Hummingbird Insights LP

Data & Image: Hummingbird Insights LP

We envision this trend to continue into FY25 at least, when we see OSUR turning a net profit of $22 million. Further clamping the upside case is that OSUR has remained free cash negative in recent years. Our projections have the company reaching profitability in free cash by FY23, where it could print $21 million below the bottom line. Operating income came in at a loss of around $16 million on the last earnings print. On these figures, profitability continues to be a headwind for the company - that first listed back in 1992 mind you.

An additional risk factor is that management failed to provide guidance on the last earnings call, only stating it expects an increase in Q2 InteliSwab sales. However it also envisions a wind down in sales from Covid collections, offset by a potential uptick in molecular solutions revenue. Covid demand, as it continues to wind down, was noted by management to be in contention still. It highlighted that conversations are ongoing with the government, however was very clear in noting that the current $205 million government contract is no guarantee as a going concern. Although, as a potential tailwind, the company did mention the CDC's $33 million grant to mail HIV self test kits en masse in the US, which OSUR should certainly benefit from. This should start in September this 2022, although the full impact may not be recognized until FY23 by our estimate. At its current share price, plus with this information now publicly available for some time, it appears that investors have priced this well into the stock already.

So despite the fact that there is potential catalysts on the horizon, including the fact that it got a new CEO - Carrie Eglington Manner, who was appointed on 4 June - the lack of visibility on its sales runway is incredibly disturbing as is a large mitigating factor in the investment debate. It leaves us with too many questions, and reduced confidence on the predictability of the company's future cash flows.

Return on common equity ("ROE") has reduced from 5.64% in Q4FY19 to -12% on the last print, whereas return on assets ("ROA") and return on invested capital ("ROIC") have compressed from 5% and 4.8% to -10.5% and -11.7% respectively in Q1 FY22. The company also has around 4X coverage over short-term liabilities from liquid assets, and 2X coverage on these from cash alone. Its capital structure is balanced between debt and equity holders, with low net gearing, meaning its sensitivity to the shifting rates regime is low.

Data & Image: Hummingbird Insights LP

Data & Image: Hummingbird Insights LP

A constructive finding is the company's management over working capital. Accounts receivable turnover has ticked up from 4X in 2019 to more than 5X in the last quarter, reducing dales day sales outstanding by more than 10 days to 72 days. At the same time, inventory turnover has ticked up slightly from 2.6X to 27X in the last print, whereas days inventory outstanding has narrowed by around seven days to 133 days. Accounts payable turnover has remained relatively flat in this period, and the culmination of these drivers has meant the cash conversion cycle has narrowed significantly from 163 days in Q4FY19 just 151 days in the last quarter. This has led to inventory to cash days narrowing to 205 days last quarter as well.

Data & Image: Hummingbird Insights LP

Data & Image: Hummingbird Insights LP

Shares are trading at ~0.86X sales and are trading at ~0.6X book value. The company has grown its book value geometrically by around 6.2% over the past 5 years, well ahead of the industry median's contraction of around 9% in the same time. The company also has around $1.55 in cash per share and $5 in book value per share, numbers that have held relatively flat over the previous years. The question is if OSUR offers return potential at this discount, or if this discount is warranted. Based on our assumptions and forward estimates, we believe the discount is warranted. The picture isn't helped by the lackluster earnings and free cash flow momentum exhibited over the past few years to date either.

Assigning this 0.86X sales to our forward sales estimates of $299 million in FY22 yields a price target of $3.57. However, we have to have a gauge of the unrealized value for shareholders at the earnings level into the coming years to correctly price this stock. Therefore, applying the same multiple to our FY23 sales estimates of $222 million, and discounting this back at a discount rate of 12.5% - one that reflects the opportunity cost of holding the (SPX) plus the current yield on long dated Treasuries - arrives at a price target of $2.35. Applying the same process to our FY24 estimates of $227 million yields a price objective of $2.14.

We also must employ a set of unambiguous measures to forecast cleaner midterm price targets. Point and figure ("P&F") charting analysis achieves this. Our findings reveal multiple downside targets yet to be realized in the $2.22-$2.42 range, with a slightly higher target located at $2.85. This corroborates with the price objectives identified above.

Data & Image: Updata Analytics

Data & Image: Updata Analytics

Forming a composite by blending these 5 inputs on an equal weighted basis, we arrive at a price objective of $2.54, leaving little to no excitement for upside potential in this name, and rounding out our neutral stance.

On the charts, shares are now trading well below cloud support and have been since late May. A descending channel has been in situ since mid May, and on balance volume ("OBV") has recently suffered a large downtick, joining a continuing downtrend in momentum.

Exhibit 7. Trading below cloud support

Data & Image: Updata Analytics

Data & Image: Updata Analytics

These trend indicators signal there is impeding downside to come in the OSUR share price. Should shares head back towards cloud support, that would rest at the $3 mark, however the trend indicators suggest that this is unlikely to happen, and we confer.

OSUR presents us with a high degree of execution risk and needs to prove itself in its many and new expanding markets. Whilst the company has the prospects for upside potential based on more qualitative and market factors, fundamentally, it lags peers and within the industry and presents us with and uncompelling growth trajectory from the top to bottom line.

Adding further compression to the upside case is the fact the company trades on a justified discount across key multiples to peers, and we've identified multiple downside price objectives, leading us to price the stock at $2.54. This leaves little to no room for share price appreciation in our estimation, and market technicals corroborate the potential for further down side. The culmination of these factors leaves us neutral on the stock, although we look forward to providing further analysis into the future.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.