Masimo: A Great, Yet A Pricey Value Creator (NASDAQ:MASI)

Masimo (MASI) has proven to be a very resilient growth company. Over the past decade the company has typically grown sales some 10% a year until it is now breaking the billion dollar revenue mark. Of interest is that margins have typically ranged around 20% as the company actually reduced the share count by a tenth over the past decade, while preserving balance sheet integrity.

While shares look pricey at the start, it is this great track record which warrants a more thorough look at the company, as long-term secular trends make quality perhaps more important than ever.

The Company

Masimo is a medical technology company which focuses on the development, manufacturing and marketing of non-invasive monitoring technologies. Non-invasive technologies are typically designed to improve patient outcomes and reduce cost of care with these technologies expanded to other applications as well, after the company was founded back in 1989.

The core business of Masimo involves measure through motion and low perfusion arterial blood oxygen saturation and pulse rate monitoring, which the company calls Masimo SET pulse oximetry. Product offerings have been expanded into other areas of care as the Root remote patient monitoring platform is enjoying solid demand as well. While pulse oximetry is a very common measurement, conventional measurements do not provide accurate results if the patient is not quietly laying down, but instead is on the move.

The company went public back in 2007 when it sold shares to the public at $17 per share. Shares rose to $40 later that year and have retreated towards a $20-$40 range until basically early 2016, marking a near decade long period of no capital gains. With 54 million shares trading at $40 early 2016, the equity valuation came in around $2.2 billion while the company reported a flattish net cash position. As the company generated more than $600 million in revenues, up 50% over a cumulative time period of around 5 years, valuations looked compelling in terms of sales multiples as the company generated over a hundred million in operating earnings as well.

Ever since, the company has seen acceleration, mostly in its share price, and to a lesser extent in the underlying business. Shares more than doubled and hit the $100 mark early 2017. This was just the start as they rose to $150 in the summer of 2019, hit a high of $180 in the weeks ahead of the COVID-19 outbreak, and after seeing a small pullback during the crisis, they hit a high of $250 in May. Ever since, shares have settled around $214 at the moment of writing as the still solid momentum is backed up by improvements in the actual operations, although only to a partial extent.

Current Valuation Thoughts

In February of this year, Masimo reported 2019 results with revenues up nearly 13% to $938 million. The company reported GAAP earnings of $3.44 per share, actually twenty-two cents above the non-GAAP metric. The company guided for 11% revenue growth in 2020, foreseeing sales at nearly $1.04 billion with GAAP earnings seen at $3.64 per share, while adjusted earnings were projected at $3.56 per share. Net cash balances of $688 million translated into a cash position of $12 per share based on a share count of 57 million shares.

With shares hitting a high of $180 ahead of the COVID-19 outbreak, operating assets were valued at $168 per share, or basically at 47 times earnings expected in 2020, very steep multiples by all means. When COVID-19 arrived shares did see an initial negative reaction yet management acted decisively as the company acquired TNI Medical AG, a German-based ventilation company in which the company already invested last summer. Besides acquiring, the innovative remote monitoring solutions of the company were in great demand in this environment as the company made real product strives during the crisis in this area as well.

Late April the company reported first quarter sales growth of 16% with revenues hitting $270 million. Growth was quite a bit stronger than the full year guidance and while COVID-19 might have provided a boost, it was only very late in the quarter as the first quarter ends on March 28. The company managed to report adjusted earnings of $0.97 per share, an eighteen cent improvement compared to the year before thanks to the revenue acceleration.

The real COVID-19 impact was seen in the second quarter results with revenues up 31% to $301 million yet margins took a small beating as adjusted earnings rose just 9 cents to $0.85 per share, marking a decline from the first quarter, all while net cash balances were largely similar.

With shares having risen to $214 per share currently, operating assets trade around $200 per share and with earnings power realistically seen below $4 per share, it is very obvious that despite a short-term boost to revenues, anticipated earnings multiples have only risen further.

What Now?

Do not get me wrong, I do not think that a 50 times earnings multiple looks anywhere close to being compelling. This is the case, even for an unleveraged business which grows sales at a sustainable growth rate of 10% per annum.

There are a few reasons which make Masimo interesting, however. For starters is that this business is very innovative and is demonstrating this during the COVID-19 crisis as the company is actually rapidly embracing ventilation technology as its remote monitoring is a real growth driver. Besides saving on costs and the fact that remote monitoring is safer for staff, it saves on staffing hours altogether, critical in this environment.

Furthermore, the company reports operating margins of 23% and while these are quite steep, there is potential for margin expansion although I would be careful to model significant further margins gains, as this is a very competitive space after all. That said, structural 10% growth for a billion dollar business is quite impressive and certainly makes the company interesting to potential acquirers, yet the issue is that expectations are simply quite high already, including for those looking to potentially acquire Masimo.

If valuations are too high for potential M&A buyers, they must be too high for regular investors as well and while Masimo is absolutely quality, and I am willing to pay up for quality, the risk-reward here certainly does not look compelling. I make this statement, recognizing that this quality name has traded at lower multiples in the past as well before embarking on a multi-year momentum run in its stock.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.

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