Retractable technology stock: what do we buy? (NYSE: RVP)
Summary of investments
Safety syringe company Retractable Technologies, Inc. (NYSE: RVP) has been somewhat of an unconvincing story over the past 12 months on the chart. With a series of structural headwinds in place, investors continue to seek clarification in this relatively opaque market. Last name. Here, we give investors an overview of what they’re buying in RVP, and note that the stock appears to offer a lack of upside/downside capture without further detail on its recognition of non-US government revenue. With these points in mind, we rate RVP neutral.
6-Month RVP Price Action
Investment Thesis Risks
Investing in small cap stocks has inherent risks due to volatility and the magnitude of potential up/down movements. By taking a neutral stance, our thesis is exposed to both upside and downside risk, if there is strong buying or selling activity respectively. Price-sensitive news in this space is likely to cause price swings that can negate our investment thesis, as fundamentals can be dislocated from market technicals. This should be kept in mind for investors reading this analysis.
Summary of Q2 results
Sales of $14.3 million (“mm”) were down 66% year-over-year from $42.5 million a year earlier. COGS margin increased 21 percentage points to 68% on revenue volume below $9.78 million, and gross profit decreased by similar amounts year-on-year to $3.7 million also taking into account royalty expenses.
Geographically, domestic sales represented approximately 67% of sales, compared to 94.4% the previous year, due to the reduction in the volume of revenues resulting from the agreement with the US government. This remains a major risk for the company in the future. On the bright side, domestic unit sales were still up around 80% year-over-year and accounted for 51% of domestic sales, while overall unit sales increased by 64% in volume. Meanwhile, on a YTD basis, international revenue increased approximately 97.5% year-on-year to $904,000 on the back of increased immunization revenue despite contracting more than 50% year-on-year.
Meanwhile, net loss was $3.6 million versus profit of $10.6 million last year, cutting earnings from $0.31/share to a loss of $0.11. $/share. This stems from an operating loss of $2.1 million as revenue declined and unit cost increased year over year.
Meanwhile, the company also announced that it would reduce its workforce by approximately 16% after the completion of recent facility expansion efforts. It is estimated that the haircut will result in annualized savings of approximately $2.1 million or 13% in annual payroll expenses of $16 million. Therefore, new labor costs are expected to be approximately $14 million. The fall in the cost of labor will also reduce capital intensity and bring the capital intensity ratio down from 1.82 to 1.59; which means he will have to spend about 12% less to generate $1 in revenue in the future.
As seen below, the capital intensity of the firm has changed over time. From the second quarter of FY19 through FY20, FCF returns rose over time and reversed course thereafter amid rapid reinvestment in the business. It maintained a double-digit return on investment as FCF returns declined, suggesting that capital budgeting initiatives have been successful, as has the growth of the business. However, since the end of FY21, ROI has returned to the range [albeit still ~35%]. Nevertheless, the downward trends of the two [combined with factors above] are not to be neglected.
Exhibit 1. ROIC and FCF returns have declined since FY20 and FY21 respectively, along with reduced contract revenue
U.S. Government Contract Update
The main surplus in the RVP investment debate remains its contract with the United States Government Department of Defense, US Army Contracting Command-Aberdeen Proving Ground, Natick Contracting Division and Edgewood Contracting Division [ACC-APG, NCD & ECD] on behalf of the Biomedical Advanced Research and Development Authority [BARDA]. It accounts for this as the Technology Investment Agreement (“TIA”). In FY21, RVP was a growth story and saw a huge upside on the chart following material orders under this deal to supply syringes for Covid-19 vaccinations.
However, although this contract has been extended and the company continues to work with the US government, additional orders are not known. Highlights detailing the bridge of this contract from the fiscal year 2020 date are outlined below:
- Beginning in July FY20, the company launched the TIA for $81 million in public funding to expand its domestic production of needles and syringes. RVP accounts for this as a deferred liability which is amortized as a gain over the life of the increase in property, plant and equipment.
- Beginning in May FY21, the TIA was modified for additional funding of approximately $27.5 million to add 12,500 square feet of controlled environment, plus 2 additional assembly lines, to further increase the existing domestic manufacturing capacity.
- As of June 30, FY22, it had negotiated contracts for the purchase of automated assembly equipment, molds and tooling, and certain ancillary equipment for $64.9 million.
- The U.S. government is also funding a temporary occupancy certificate for the $6.7 million 27,800 square foot controlled environment, and the company received the occupancy certificate for the new 55,000 square foot warehouse of 5 .9 million.
The current parts of the facilities under contract are shown below:
Exhibit 2. RVP long-term deferred liability for TIA, Q2 FY22
Exhibit 3. Current share of US government sales, down from $12.72 million to $9.56 million
This trend remains the main risk for the company going forward, as Covid-19 cases/vaccines continue to decline, just as US government revenues are likely to decline as well.
In this vein, investors should consider this increasingly smaller slice of revenue contribution going forward. It also reduces the predictability of RVP’s future cash flows and therefore impacts enterprise value measures.
As we have seen insight into the continued value of RVP [historical and forward-looking earnings]we also need to make several adjustments to GAAP earnings to clean up the picture.
Let’s first see what we buy in RVP. We capitalize $206,000 in R&D expenses on the balance sheet and remove a deferred tax asset of $9.6 million to see the equity value adjust to $93 million from $102.5 million. We have $45 million more retained earnings and an adjusted tangible book of $76 million. We also purchase tangible assets of $96.7 million which are depreciated over 39 years and therefore retain strategic value on the balance sheet. As we have seen, capital intensity is low.
Exhibit 4. Reconciliations with GAAP earnings to extract true value
As noted, the shares are trading at a respective discount to book value. The question is, does this represent value or are the shares fairly priced at this discount? After adjustment, we would implicitly pay $0.86 to $2.11, each the respective discount from the current market price. Even on unadjusted values we would pay a discount.
Exhibit 5. Book value adjustments result in improved implied cost per share
In light of the investment value analysis of RVP above, and in terms of continued value [earnings]we see shares at a fair price of $2.97, with adjusted forward EPS of $1.10 [Exhibit 6]. Therefore, we do not see attractive value at these levels as we capture less than $1 per share up from current market value.
This allows investors to better understand exactly what they are buying under this relatively opaque name. Based on our analysis, we choose to refrain from being buyers at this stage, as we seek clarification on the company’s non-US government revenue recognition. In this vein, we value the stock at $2.97.