Neuronetics Is Undervalued, There Seems To Be A 40% Upside Potential

Neuronetics (NASDAQ:STIM) recently released a solid quarterly report that included 30.94% revenue growth and a massive amount of cash. Almost 90% of its total amount of assets is represented by cash. The market did not seem to assess the figures reported and pushed the stock price down in November. At current prices, the company seems very undervalued as compared to peers. It trades at 3.2x forward sales, with other peers trading at 7.60x sales. With this in mind, there seems to be a 40% upside potential in the stock price.

Business

Founded in 2003 and headquartered in Malvern, Pennsylvania, Neuronetics, Inc. is a commercial-stage medical device company focused on the treatment of major depression.

(Source: 10-Q)

Neuronetics’ most relevant device is the NeuroStar Advanced Therapy System, which uses transcranial magnetic stimulation to create a pulsed, MRI-strength magnetic field that produces electrical currents designed to stimulate specific areas of the brain associated with mood. The device is shown in the image below:

(Source: Company website)

The product was accepted by the FDA in 2008 to treat major depressive disorder in patients for whom antidepressant medication has failed. The result of trials executed by Neuronetics showed that 58% of patients responded well to the treatment and 37% reported remission. Readers can get further details in the lines below:

(Source: Company website)

Hospitals and doctors seem to appreciate its technology. As of March 31, 2018, Neuronetics had installed 781 active systems in the United States. In addition, according to the company’s estimates, 33% of patients who meet its labeled indication and are insured are clients of Neuronetics.

Market Opportunity

The market opportunity does not seem very large. According to the World Health Organization, 300 million people are suffering from depression. In the US, according to the U.S. Census Bureau data, approximately 21 million people suffer from major depression, and 13.3 million adults are being treated by a psychiatrist. Among these patients, the company estimates that only 5.5 million failed to achieve remission after antidepressant medication therapy.

With a small target market, investors should keep in mind that the company sells the device for large sums of money. Neuronetics should be profitable in the long term.

More Sales Personnel And More Brand Awareness

Let’s put in perspective the most recent efforts of Neuronetics for those who could not read previous reports. The company seems to be increasing the number of sales personnel as well as its sales expenditure. As a result, it has been able to show an impressive increase in the amount of revenues in 2018. Take a look at the revenue growth in the chart below:

(Source: YCharts – Seeking Alpha)

In the most recent earnings call, the company noted that it is adding new salespeople and has created a Chief Commercial Officer role. The lines below provide further details on this matter:

(Source: Earnings Call transcript on Seeking Alpha)

Along with the addition of sales personnel, Neuronetics is investing in digital marketing. It was reported in the earnings call that the ads the company paid for were increasing the brand awareness. An assessment of Google Trends data seems to confirm this feature. Read the following lines and note how the number of searches of the word “NeuroStar” increased in 2018:

(Source: Earnings Call transcript on Seeking Alpha)

(Source: Google Trends)

90% Of The Total Amount Of Cash Is Represented By Cash

Neuronetics’ financial situation improved a lot after the IPO. The company went from reporting an asset/liability ratio of 0.87x in December 2017 to show a ratio of 2.79x. Additionally, its cash in hand increased from $29.14 million in 2017 to $106.76 million on September 30, 2018. Investors should also appreciate that almost 90% of the total amount of assets is represented by cash.

On the liability side, it is beneficial that the amount of liabilities decreased from $44.45 million as of December 31, 2017, to $42.6 million as of September 30, 2018. Its long-term debt equals approximately $25 million, and the current portion of the long-term debt equals $5 million. With $106.76 million in cash, this amount of debt should not worry investors. The image below provides the assets and liabilities reported in the last quarterly report:

(Source: 10-Q)

The increase in cash is not the only interesting feature that investors should appreciate. The conversion of all the preferred stock is very positive. Investors should not worry about potential stock dilution from these convertible securities:

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(Source: 10-Q)

30.94% Revenue Growth

Neuronetics’ growth reported in the three months ended September 30, 2018, was quite strong. As compared to the same quarter in 2017, revenue increased by 30.94% to $13.737 million. With that, it is also quite beneficial that the gross profit also increased. The company reported gross profit of $10.703 million in the three months ended September 30, 2018.

On the bottom line, the financial performance was not that appealing. Neuronetics increased the amount of sales expenditure from $6.56 million to $9.67 million. The research & development expenditures also increased by 15% to $2.125 million. As a result, the company reported losses of -$4.96 million, which is a bit worse than the figure of $3.7 million reported in 2017.

With that, let’s note that growth investors may not really look at the losses. If the company continues reporting revenue growth and fat gross profit margins, shareholders should be benefited in the long run. The image below provides the income statement reported in the last quarter:

(Source: 10-Q)

In the earnings call, Neuronetics noted that the sales increase was due to the new commercial strategy. Read the lines below for further details on this matter:

(Source: Earnings Call transcript on Seeking Alpha)

The most interesting of the call was the guidance. Neuronetics expects to report revenue growth of 26-30% y/y, amounting to $51-52.5 million in 2018. The lines below provide further details on this matter.

(Source: Earnings Call transcript on Seeking Alpha)

This seems very beneficial for shareholders, and it is a pity that the market did not react to this information. As of November 20, 2018, the share price declined to $16, down more than 40% in only three months. Take a look at the image below:

(Source YCharts)

Valuation

As of November 20, 2018, with 17.58 million shares at $16, the market capitalization equals $281 million. Adding debt of $30 million and deducting cash of $106 million, the total enterprise value equals $205 million.

Let’s assume 2019 forward revenues of $64 million, which seems reasonable after adding additional 26% revenue growth. With this figure in mind, the company trades at 3.2x sales, which seems low as compared to peers.

Brainsway Ltd. (OTCPK:BRSYF), which sells technology that is similar to that of Neuronetics, trades at 7.60x sales with a gross profit margin of 77%. Brainsway reports revenue growth of 46.16%, which is larger than that of Neuronetics. So, it is reasonable that Brainsway’s ratio is larger than that of Neuronetics. However, as of today, the difference seems too large. Neuronetics could trade at 5x-6x forward sales, or $22.5-26.

Conclusion

After releasing a solid quarterly report with 30.94% revenue growth, the market did not seem to react positively. The global decline in the equity markets seems to be the reason for value destruction, as Neuronetics’ numbers seem very solid. Keep in mind that the company is small. When global markets decline, small caps are usually punished more than large corporations.

As of November 21, 2018, the company seems undervalued at 3.2x sales. Other peers like Brainsway Ltd. trade at 7.60x sales with similar gross profit margins. There seems to be a 40% upside potential in the stock price.

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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