Is Outset Medical Stock a Hidden Gem?

While attention has shifted toward AI firms in recent months, healthcare stocks can still offer excellent growth potential. One small company that has flown under the radar is Outset Medical (NASDAQ:OM), a medical device company that helps sufferers of chronic kidney disease.

Outset Medical builds and sells a new dialysis device called Tablo, an all-in-one machine to make dialysis easier on patients and simpler for healthcare providers. It’s designed for use in both clinical and home settings, and the simple user interface allows healthcare providers to be trained on it in a matter of hours.

Impressive Top Line & Market Size

In Q3, Outset Medical’s revenues reached $30.4 million, a 9% increase from the year-ago quarter. Product sales accounted for $23.5 million of the total and the balance of $6.8 million came from services.

Overall gross margin climbed 15.6% this quarter from a year ago to 23.6% and rose on products alone at a considerably higher rate, advancing from 9.7% to 28.4%.

On a GAAP basis, the company was less impressive, though, losing $0.93 per share in Q3, down from a loss of $0.85 the previous year, a significant miss compared to analysts’ consensus estimate of -$0.79 per share.

Looking to the future, Wall Street forecasts that OM will remain in the red throughout next year. Losses for the trailing 12-month period totaled over $162 million, well above the company’s total sales of $115 million.

With that said, the company’s potential market could be quite large in the long run. The global dialysis market is currently worth almost $95 billion, and growth in aging populations is expected to result in a CAGR of 6.8% through 2030.

An estimated 37 million Americans suffer from some form of kidney disease, of which about 562,000 are currently on dialysis. As such, innovative dialysis solutions like Tablo have significant room for growth.

For the full fiscal year, Outset expects to bring in roughly $130 million in revenue and hit a gross profit margin of slightly over 20%. On a forward 12-month basis, analysts estimate the company’s revenues will grow at a rate of about 13.3%.

Is Outset Medical Stock Undervalued?

Outset Medical stock is undervalued by 42% according to the consensus estimate of five analysts with a price target of $7.40 per share.

The range of estimates from $3 to $14 per share is wide enough to give investors pause as to the conviction they can have in these forecasts.

Nonetheless, for a company with a market capitalization of under $250 million and significant growth potential, Outset trades at reasonable valuation multiples. The stock is currently priced at 2.1x sales and 0.96x book value.

With further market share traction, long-term sales could eventually rise to several times their current levels.

FDA Warning Sparked Share Price Fall

Outset Medical has a tumultuous history around FDA approval for Tablo. While the device has received FDA approval, the company received a warning letter from the agency in July.

In that letter, the FDA warned Outset that its website was marketing Tablo for uses beyond what the agency had approved at that time. This warning later caused Outset to downgrade its revenue guidance for the year, triggering a rapid share price decline.

Another challenge for the firm may be related to the balance sheet. Specifically, mounting losses could hurt cash reserves. Total net losses in Q3 were $46.2 million, while the company’s reserve of cash and cash equivalents was $197 million.

The company’s debt-to-equity ratio already stands at 0.64, so further borrowing in today’s high interest rate environment could saddle the company with large interest expenses. Even if losses narrow over the coming year, management may be forced to borrow or issue additional shares to fund its ongoing R&D efforts.

A final hurdle for Outset is its somewhat slow forward rate of revenue growth. At such an early stage, investors typically prefer to see much higher revenue growth rates from companies that have not yet become profitable.

While the forward revenue growth estimate of 13% isn’t terrible, it may not be sufficient to support significantly higher share prices over the coming year.

Is Outset Medical a Buy?

Outset Medical’s innovative approach to a common and inconvenient medical procedure provides it with a significant opportunity for future growth and the recent quarterly results show the beginnings of stable sales that could continue well into the future. As Tablo is more widely used, Outset services revenues should increase to comprise a larger share of total revenues.

The problem, however, is that Outset faces a long and uncertain road to profitability. With quarterly losses of nearly $1 per share expected to continue through next year, the company is unlikely to make much progress toward breakeven in the near future making it difficult to predict when investors will see positive earnings.

It’s also worth noting that Outset Medical shows some of the characteristics of a value trap. While its price ratios may look appealing given its small current sales and growth potential, the company’s stock has plummeted over the past year.

Down more than 75% in the last 12 months, Outset has already saddled shareholders with steep losses. Although the Q3 earnings report gave the stock a much-needed bump, OM could remain highly volatile for the foreseeable future.

Overall, Outset Medical’s appealing market opportunity appears to be overshadowed by its risks and long road to profitability. Although the company may succeed in the long run, the stock is currently too uncertain to appeal to most investors.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.