Research Notes: Pandemic Turnarounds
Looking for 2022 value in 2020's hottest stocks
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It’s no secret that so-called “pandemic winners” of 2020 have been crushed as normalcy returns. Nor is it necessarily a surprise.
Particularly for the most direct beneficiaries — vaccine manufacturers, PPE (personal protective equipment) makers, Covid test providers — sales and profits generated at the peak of the pandemic were not sustainable. To some extent, the market did price in a reversal — but (as we shall see) not quite on the scale that we’ve seen in 2022.
Indirect beneficiaries received a boost that clearly was much greater than most investors would have predicted in, say, June 2020. For instance, few investors or analysts projected the massive profits that formerly struggling US retailers would post in 2021.
Of course, combining that boost with an overheated market meant those stocks also ran too far. Many — retailers first and foremost — have been crushed over the past few months.
The question is whether some of these pandemic winners-turned-losers have value. More than a few have returned to near or even below pre-pandemic valuations, despite generating significant amounts of cash over the past nine quarters or so.
In that context, the combination of ugly near-term results, sentiment toward the category, and a volatile broad market might offer some opportunity. And so it’s worth taking a look at some of the biggest pandemic losers to see if any can reverse their recent trend.
At the end of 2019, Co-Diagnostics CODX traded at 90 cents, giving the company a market capitalization of roughly $16 million and an enterprise value of ~$15 million. CODX closed Wednesday at $3.29 — but now has an EV of just $22 million1.
That profile is why Co-Diagnostics sent us down this proverbial rabbit hole (admittedly a very deep one). This is ostensibly a better business now — possibly a much better business. At the end of 2019, the molecular diagnosis developer had less than $1 million in cash on the balance sheet. It had just completed a year in which it burned $5.6 million and generated $215,000 in revenue. Granted, that latter figure had risen more than 400% year-over-year, but the company’s runway seemed awfully short.
In early 2020, however, the company moved its Covid-19 test from the beginning of development to FDA approval in about three months — which has to mean something in terms of its capabilities. The company then earned $42.5 million in net income in 2020 and $36.7 million in 2021.
Obviously, Covid-19 tests aren’t driving those kinds of profits ever again. But testing probably should pick up again somewhat over the winter. Co-Diagnostics now is developing tests for monkeypox, and the original business plan to develop liquid biopsies for cancers and tests for mosquito-borne diseases still exists.
That wasn’t a great business plan, perhaps: Co-Diagnostics’ 2017 IPO only valued the company at ~$70 million, and raised just $7 million gross. CODX stock went pretty much straight down from there.
Still, even accounting for a likely return to cash burn, the current valuation applied to those efforts doesn’t seem much different. Depending on an investor’s perception of Covid-19 demand going forward, the implied valuation on the rest of the business might be (probably is?) negative.
It’s hard to not be at least a little intrigued here. Some investors already are: CODX jumped 5.8% on Wednesday. In this market — and in this world — there’s a possibility of owning CODX and waking up to a 40% premarket gain because somebody somewhere ate a marmoset. With some downside protection from cash — almost $3 per share net — there are more expensive lottery tickets out there.
But there seem to be two big catches.
The first is the general nature of these low enterprise value plays. Yes, theoretically the risk is low, since the stock shouldn’t trade that much below its cash balance (though how much below is an interesting discussion2). But, of course, so are the rewards. If CODX's EV doubles, the stock on paper rises ~20%, even if in practice the story probably isn't quite that simple. (CODX's EV increased ~40% just on Wednesday, for instance.)
The second is what, precisely management plans to do with that cash. What they did in Q2 was not optimal. In the second quarter, Co-Diagnostics revenue of $5.0 million declined 82% year-over-year; the figure was more than 75 percent below consensus. In May and June — which savvy CFOs know are months that, you know, fall in the second quarter — the company bought back ~1.5% of shares outstanding for an average price of $4.88.
That trade briefly looked smart as CODX roared back to $7 — but the disastrous report has halved the stock. It’s not clear why that reaction was a surprise to the Co-Diagnostics board: again, consensus revenue (from four estimates) was more than quadruple what the company actually generated. Perhaps more importantly, the quarter signals the very real possibility that the Covid-19 business is finished as a material generator of profit.
Those two issues suffice to keep CODX out of the buy zone for now. But the broader profile remains intriguing enough to at least keep the stock on the watchlist, particularly with the possibility of further sell-offs in small and micro-caps.
Zoom Video Communications
We talked about Zoom Video Communications ZM , one of the biggest pandemic winners two weeks ago after the company tanked fiscal Q2 earnings. The stock is about flat to where it was then, and to my eye still looks a little intriguing (though, as with CODX, not intriguing enough to put money behind just yet).
I looked at the bull thesis for Peloton Interactive PTON and it has its points. For the deservedly damaged reputation of PTON as a stock (shares incredibly are down 94% from their January 2021 high), customers still seem on board. Peloton ostensibly can get to a business model along the lines of Roku (ROKU), in which the product is a loss leader and the profit comes from high-margin subscription revenue (a different type of revenue than that of Roku, obviously, but the financial point still holds).
But there are two roadblocks here, as well. The most notable is that it’s simply really difficult to own any fitness stock. Planet Fitness (PLNT) is perhaps the only winner in recent years; Life Time Fitness went private in 2015, and shareholders did well there. On the other hand, Town Sports and Bally Fitness went bankrupt (I’m sure there are others; Peloton’s kind-of-sort-of peer Nautilus (NLS) has had an unbelievable round-trip. Stretching the definition of ‘fitness’ stock somewhat, Weight Watchers (WW) has seen the same trajectory.
The other issue is that Peloton still has a market cap of ~$3.5 billion. Add in a couple more quarters of losses (even in an optimistic scenario) and enterprise value clears $4B. Is there really a path for that figure to get back to even $8 billion? That’s the kind of upside required to take on the risk and patience required in the name.
Cost-cutting alone doesn’t do that. Getting to that level means Peloton continues with both some level of new equipment sales and relatively low churn. That needs to occur even in a recessionary/inflationary environment when consumers are tightening their proverbial belts.
PTON at the least has moved to a point where there’s a logical bull case. As with so many stocks on this list, I’m not quite convinced it’s yet logical enough.
The long-term chart seems to show the case for shorting Generac Holdings GNRC :
The manufacturer of generators and, more recently, an acquirer of clean energy companies was a pedestrian business for most of the last decade. Then the pandemic hit, demand went nuts, and EPS nearly doubled in two years. An exuberant market expanded the P/E multiple from ~20x to ~50x over that same stretch before a reversal this year.
We’ve recommended shorts of boating stocks and, last weekend, Harley-Davidson (HOG), based on theses that should be similar to that of GNRC. Demand was pulled forward in 2020-2021, creating a multi-year headwind going forward. Inflation is on the way, pressuring both input costs and demand. The strong dollar boosts foreign competitors. And while HOG and most boating stocks are trading at single-digit multiples to this year’s earnings, GNRC is at 17.5x.
Indeed, GNRC has a pretty hefty short interest at over 10%. Spruce Point Capital issued a short report on the stock in June, pointing to this broader thesis as well as supposed financial improprieties3.
Admittedly, Generac’s performance hasn’t slowed down yet: the company just posted a record Q2, and the Street sees EPS growth of of 25%-plus this year. (The average target on the stock also suggests 70% upside. That’s not dispositive, but it’s something.) But good investors “skate to where the puck is going,” and there is a case that earnings here are going to reverse in a hurry.
That said, the case seems a bit too easy, particularly in this market. Look around: investors are punishing pandemic winners not just on performance, but valuations. And in the case of boating stocks and RV names, those investors did not wait for revenue to start declining before compressing the multiples toward those assigned businesses at peak earnings. Indeed, the debate over those stocks, particularly now, really is about how insane the peak was and how long and painful the hangover will be. It’s not about whether the stock should be priced for growth from here, as GNRC is.
Clean energy exposure no doubt is helping the stock, and admittedly that does seem like a trend that offers some short opportunities. GNRC may not be the best one, however: there is no shortage of questionable names in that group that have rallied sharply since July, when the Build Back Better bill was resuscitated.
All told, GNRC at $212 has an interesting short case. But it’s also the kind of stock where the opportunity might be better at $180 after an earnings miss. It’s weird to say about a stock down 60%, but a short probably works best here when cracks in the business really begin to show and investor perception changes.
Moderna MRNA too got a writeup this month, and readers will be shocked — shocked! — to see another display of expertly-written fence-sitting.
In our defense, there simply haven’t been this many companies with such incredible volatility in both earnings and valuations4 in such a short amount of time. Again, CODX revenue missed consensus by more than 75%, a comically absurd figure.
But it’s worth reiterating another aspect of the CODX story that might apply to MRNA: current sentiment toward Covid-19. Are investors a little too focused on the carefree, Covid thought-free, summertime, and forgetting about higher winter transmissions and the inevitable Pi variant that will arrive?
Right now, Moderna seems like a play on boosters. If annual boosters see significant adoption, MRNA rises over the mid-term. If not, it doesn’t. It’s wouldn’t be a surprise if investors — most of whom appear to be living essentially normal lives at this point — were predicting the latter scenario in September, only to change their mind when Covid-19 inevitably intrudes again.
As of this writing, Vince Martin has a long position in VOXX.
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My calculation of enterprise value here treats contingent consideration liabilities currently carried at $6.4 million as debt.
One fascinating, and unanswerable, question is: what is a dollar of cash in a corporate Treasury worth? The response no doubt varies from company to company; in some cases, the discount probably should be relatively severe. (For VOXX International (VOXX), in which I still own a small stake, this has been a long-running concern.) But the answer absolutely is not $1, despite the fact that many investors (ourselves included) often do the math that way.
We try not to criticize other writers, so we’ll leave this to the footnote…Spruce Point’s “forensic accounting” seems to miss the mark quite a bit. More broadly, there’s a real sense of the facts getting fit to the thesis.
Obviously, entire sectors have seen parabolic rallies and collapses. In recent memory, crypto and cannabis stocks have performed that way; so did the most speculative de-SPAC mergers.
But the volatility in pandemic winners has been driven by incredible changes in their actual profits. Moderna, for instance, was a typically unprofitable biotech in 2019 and earned $12.2 billion in 2021. To put that in context, on an adjusted basis Nvidia (NVDA) generated $1 billion less in net profit during its fiscal 2022 (ending Jan. 30).