Sharps Compliance’s Attractive Position In Healthcare Waste Management (NASDAQ:SMED)


Introduction

Sharps Compliance is a $108 million market cap medical waste management company. It is sparsely covered by analysts. The company is experiencing revenue growth and has a strong competitive position. Sharps is attractive at the current growth rate. In addition it has substantial upside as could benefit enormously from a COVID19 vaccination campaign. We initiate rating of the company with a Buy recommendation.

Overview

A micro-cap company focusing on healthcare waste management

Sharps Compliance is a provider of disposal solutions for medical waste and unused medications. The company provides specialized disposal containers, advises on their use, collects them, and destroys the waste in a compliant manner. Quoting the CEO:

“We see our services as essential in supporting healthcare during the current COVID-19 pandemic and as such, we are prepared for what could be a very busy 2020 and 2021.” – David Tusa, 2020

The company divides its portfolio of products in two main areas:

  1. Disposal of “sharps” and other medical waste: these are syringes, needles, and other medical elements, which require adequate handling to avoid safety hazards.
    • Highly specialized in small- to medium-sized generators of waste. Examples of clients are pharmacies, MD & dentist offices, community clinics, senior care homes.
    • This area represents 72% of revenue and grows at a 10% YoY rate.
    • Sharps Compliance market penetration in this segment is less than 4% of its total addressable market, implying that expansion opportunities for the company abound (source: investor’s presentation Sep 2020.)
  2. Disposal of unused medications: both OTC and prescription drugs, being the latter of particular importance in areas where the opioid crisis has been more damaging.
    • The company places safe containers in public areas of hospitals, pharmacies, universities, US military bases, and local administration buildings. As per National Safety Council, the approximate cost for these organizations is $3,000/year, which includes shipping and disposal costs paid to Sharps Compliance.
    • 18% of the company’s total revenue, growing at a 32% YoY rate.
    • The self reported market penetration for Sharps Compliance in this market is less than 1% of the total market size (source: investor’s presentation Sep 2020.) There is ample space for growth in this segment.

Figure 1 – MedSafe in the University of Michigan (source: umich.edu)

Figure 2 – MedSafe in an Airforce base (source: hanscom.af.mil)

From the Space City

The company has its headquarters in Houston, Texas. Other locations to highlight are:

  • Carthage, TX: Sharps Compliance owns one of the only 10 permitted incinerators in the US for medical waste and unused medications, located in Carthage, Texas. In that location it also owns and operates two autoclaves.
  • Nesquehoning, PA: The company is also expanding its autoclave facilities in Nesquehoning, Pennsylvania, where it already owns one and is adding a second autoclave.

Sharps Compliances owned routes provide service to 32 states and 70% of US population:

Figure 3 – Route coverage (source: corporate website)

An executive team with an accounting background

David Tusa is the CEO and President of the company. He graduated from University of Houston and joined Sharps in the late 1990s. Before Sharps, he worked for KPMG as an auditor, among other roles. Mr. Tusa holds a CPA certification.

The CFO Diana P Diaz also holds a CPA certification, in addition to an MBA degree from Rice University.

Sharps Compliance went public in 2009

The company was founded in 1992. During the early 2000s it started trading OTC. It wasn’t until 2009 that Sharps Compliance did its IPO. The way we see it, the company is a steady player that has accelerated growth in the last five years with a 10.6% CAGR in revenue as per SEC filings.

Flu season is the best season… for Sharps

Sharps Compliance is a company that benefits from the flu season, as it is estimated that 45% of adult Americans typically receive a seasonal flu immunization and this medical material needs to be safely disposed. The company’s flagship product helps dispose needles and syringes, benefiting from this recurring yearly campaign.

Analysis

The company’s competitive advantage grows with time

We see Sharps Compliance essentially as a logistics network for medical waste of clients that require compliant disposal solutions. As any other logistics organization, the company features network economies that are their moat against competition. The company has differentiated itself from the heavy-weights of medical waste management by focusing on small- to mid-size clients. These clients were previously underserved by the mammoths of the industry, and Sharps Compliance fills efficiently that service gap.

Figure 4 – Sharps Compliance business is similar to other logistics operators

As a logistics network, the more Sharps Compliance grows, the more effective it will be improving margins in the future and servicing clients expeditiously. These business characteristics are what we find attractive in Sharps. Particularly remarkable is that Sharps is now a small company with a minuscule market share but still delivers 30% gross margin and growth. If the management team continues its good practices, results will keep improving as the company grows.

Moreover, because of the regulated nature of the medical waste management business, Sharps Compliance can continue improving its margins by getting more licenses for restricted facilities as the company grows. It already holds one incinerator license, a type of facility that is a regulatory-based oligopoly as there are only 10 approved by the US government. This furthers the case of a strong competitive position for Sharps Compliance.

Revenue growth and low debt

The company has taken some time to reach consistent profitability but we believe now it’s here to stay. As per the last earnings call in Sep 2020 (end of fiscal year for Sharps Compliance), these are the metrics we found most illustrative:

  • Revenue growth of 15.3% YoY.
  • Earnings per share was $0.14. This compares to $0.01 EPS for the previous year. However $0.10 of this EPS amount was due to a one time tax benefit (the company recognized previously unrecognized GAAP tax benefits associated with prior year GAAP losses.)
  • Gross margin of 31%.
  • Minimal long term debt, which stands at $3.5 million as per their earnings report.

Figure 5 – Yearly revenue growth since 2013 (source: corporate website)

The management team needs to get SG&A expenses under control

During the last few years of revenue growth, SG&A expenses have been growing at a comparable rate, which looks to be the reason why profitability has been elusive in the previous years. CFO Diana Diaz explained in the last earnings call that these expenses are growing as the company is expanding headcount and budget for sales and marketing. FY2020 experienced a +17% increase in SG&A, while Ms. Diaz projected a +11% to +13% SG&A increase for FY2021. These expenses need to decelerate or overall revenue needs to grow faster.

Negative stock Beta

In addition to the financials described previously, an important characteristic of the Sharps Compliance stock is its negative Beta of -0.45 (measured monthly for the last 5 years.) We like low Beta stocks because they help reduce overall portfolio volatility. In this case a negative Beta while having positive expected returns makes Sharps Compliance more interesting.

Option markets signal positive investor sentiment

We usually look at the option markets to analyze price expectations and hedging needs for publicly traded stocks. It is not unusual for large investors to take positions in the options markets instead of the spot markets for stocks that are thinly traded, or in situations where the investor just wants a more indirect way to take an interest in a company.

In the case of Sharps Compliance, we noticed that the contract with the most open interest is the $10 strike Call option with expiration date February 21st, 2021. This represents a +51% increase compared to the current stock price (10/8/2020.)

The Put/Call ratio sits at 0.3, meaning that for every Put option contract there are 3.3 Call options in open interest.

These options data points are indicators confirming optimism in the market about Sharps Compliance.

Rarely covered stock by analysts

We have noticed that Sharps Compliance has not been covered with a recommendation by Seeking Alpha writers in the last two years. From traditional Wall Street analysts, there had been two firms initiating coverage in the last 24 months: one is Lake Street, which issued a buy recommendation, and the other is ROTH Capital, which also issued a buy recommendation almost 16 months ago. Stifel, which was already covering the company, upgraded from hold to buy.

The right time to initiate a position

There has been a major pullback from $8.99 in early August to the current levels of $6.63 (10/8/2020). This is a -27% contraction of price in two months, for a company that keeps improving its fundamentals. We believe the price pullback happened because of low liquidity in the stock ticker as this is a $108 million market cap stock, which provoked a disproportionate impact on price when executives sold their stock compensation this quarter. The current share price is temporarily depressed, representing a buying opportunity at current prices.

SMED Sharps Compliance Corp. daily Stock Chart

Figure 6 – Sharps Compliance stock price chart

In case of a mass vaccination campaign due to COVID19, the stock price may skyrocket

As per Sep 2020 earnings call, the company is expecting a substantial increase in demand of their Sharps Recovery Kits in case there is a COVID19 vaccination campaign. This is reasonable considering there would be hundreds of millions of syringes requiring to be safely disposed if such event happens.

CEO David Tusa referred to the opportunity of COVID-19 as “three times to four times as many Mailbacks [Sharps Mailback Disposal kits]“. Considering that the Mailback product represented 53% of the revenue of previous quarter (as per comments of CFO Diana Diaz during the call), a 3x increase in this product would imply approximately a 2x increase in total company revenue, while a 4x increase in Mailback product sales would imply a 2.5x increase in total company revenue.

Conclusion

A company with 30% gross margin and steady revenue growth, Sharps Compliance is a stock with potential that has been overlooked because of its small size. The macro picture benefits greatly the prospects of Sharps, and its management team seems focused on seizing the opportunity. The stock price has been hit recently and we see this as an advantage. With little long term debt and significant competitive advantages, our recommendation for Sharps Compliance is Buy. As an area of improvement, we recommend management to reduce SG&A.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SMED over 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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