June 5, 2018 by InvestorDestination Team
Last quarter Sharps Compliance (NASDAQ:SMED) margin declined, and the company blamed it on the bad weather. Now its stock price has hit our entry point, so let us take a closer look at it.
Sharps Compliance (NASDAQ:SMED) is a vertically integrated, a full-service medical waste management company. It handles unused medications and medical waste. It was offering only mail back services, but in recent years it is also offering pickup service.
It serves different markets such as government, home health care, retail clinics and immunizing pharmacies, pharmaceutical manufacturers, professional offices (physicians, dentists, and veterinarians) and hospitality (including assisted living facilities, hotels, motels, and restaurants). Its majority of the revenue comes from home health care and retail market. It provides different solutions to its customers need.
| 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |
|---|---|---|---|---|---|---|---|---|---|---|
| Revenue (in thousands) | 12,841 | 20,297 | 39,156 | 19,395 | 21,787 | 21,530 | 26,570 | 30,902 | 33,383 | 28,188 |
| EPS | 0.01 | 0.30 | 0.63 | (0.20) | (0.24) | (0.18) | 0.06 | 0.07 | 0.00 | (0.08) |
| Revenue Growth | 7% | 58% | 93% | (50%) | 12% | (1%) | 23% | 16% | 8% | 14% |
| Operating Margin | 1% | 21% | 24% | (15%) | (17%) | (13%) | 4% | 4% | 0% | (3%) |
| Debt to Asset | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 0% | 8% | |
| FCF % Sale | (1%) | 12% | 16% | (3%) | (4%) | (9%) | (4%) | 5% | (2%) | (8%) |
In 2009, the company acquired a large government contract and expanded infrastructure to support that contract. After three years, the government ended the contract prematurely. The company was left with unused capacity and was under loss. When it couldn’t generate the lost revenue from the contract, the company closed down a treatment facility and reduced its cost. The company decided to grow its recurring revenue by increasing its presence in the professional market. It expanded its inside sales team and grew its professional market revenue. During this time, the company might have realized some of its customers prefer pickup services, so it decided to offer route-based pickup service. In 2015, it introduced a pickup service in Texas and then acquired two companies that provided pickup service in Northeast. The company needed to expand the treatment facility to support its growth. Transporting medical waste from Northeast to its central facility in Texas would have increased its transportation cost, so the company opened a new treatment facility in Northeast.
It is a regional player that had presence only in Southwest and now has expanded into Northeast
Last quarter its margins declined and the company blamed it on severe weather. Apart from the severe weather, expansion is taking a toll on its profitability. Since 2015 its margin is on the decline. The company's acquisitions have resulted in increased goodwill and intangible assets. Its depreciation and amortization expense has increased because of its infrastructure expansion and acquisitions. It is not yet fully utilizing its treatment capacity. So its gross margin has declined. The professional market is fragmented, so customer acquisition cost is relatively high for this segment. The company has expanded its sales team to grow its professional market. That resulted in higher SGA expense.
Its infrastructure expansion and higher operating expenses have negatively impacted its free cash flow.
The company is planning to process third-party waste to increase its capacity utilization. Recently, the company has acquired a large contract and expects to start generating revenue in September. So its gross margin will improve.
Medical waste management companies generate higher margin from a smaller doctor office than a large hospital. According to Stericycle, large hospitals are acquiring small doctors’ offices, and they are trying to cut cost. This trend is will negatively impact medical waste business.
Innovation in medical waste business is to safely collect, transfer and process unused medication and medical waste. This small company tries to innovate. In 2014, it introduced a new product called Med Safe targeting government sector. The company also marketed that product to retail pharmacies and had a good initial response. However, last year some of the retail pharmacies have introduced their version of MedSafe product. Recently the company has acquired new customers for its Medsafe and growing that business. While Medsafe helps to battle Opioid crisis, it is a low margin business.
After a few years of growth, its professional market growth has plateaued. Now, route-based pickup service is helping to grow its recurring revenue. However being a small player, it doesn’t have the route density of the industry leader Stericycle. Its route-based pickup service is cannibalizing its mail back. However, having both pickup and mail-back services is an advantage. Now it can offer different solutions to different customers.
The company is trying to reduce its dependency on flu season and growing its recurring revenue. Medsafe might be a low margin business, but it is helping the company to diversify. With route-based pickup service, the company is in a better position to offer different solutions to different customers. It is a conservatively managed company. It has a relatively strong balance sheet. It is low beta stock, and its business doesn’t depend on the economy. So it is worth considering.
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