Companies like Cochlear have a significantly different impact on society than companies like Aristocrat Gaming. On the one hand, Cochlear paid genius scientists to invent new ways to restore hearing to anyone from a baby to a great-grandparent. On the other hand Aristrocrat was taking government money to subsidise research and development into how best to addict people to pokies machines.
To my mind, Polynovo is a lot like Cochlear, in terms of the impact it has on people. Check out the short video below, to see one patient’s testimony.
PolyNovo is a company that sells products for rehabilitating major injuries. Its major product is NovoSorb BTM, which provides the structure for the regeneration of the dermal layer. This is the layer below the skin, and it needs to be regenerated when patients have suffered a major burn or deep injury.
Its second product is Novosorb MTX, which provides the same polyurethane matrix as BTM but without the sealing membrane. This means it can be used in deeper wounds where contraction is acceptable.
PolyNovo has only just crossed over into profitability, so it is very hard to value accurately based on profits. However, what we do know for certain is that revenue growth has been very impressive, as the company has continually gained market share, particularly in the USA.
With a market capitalisation of $1.43 billion, and just a few million profit, PolyNovo absolutely must contain expenses while continuing to grow profit if it is to justify its market capitalisation, let alone generate significant returns for investors.
However, while prima facie, the $1.43b price tag for a company that earned profit before tax of just $1.7m in FY 2024 might seem absurd, I think that it is possible to imagine a trajectory whereby the company does grow into its valuation. I’ve illustrated one such scenario below (though please note this is not a forecast.)
The scenario above assumes that revenue growth rates slowly decline but expense growth rates decline more quickly. By way of sanity-checking this outcome, the profit before tax margins in H2 FY 2027 in this scenario would be about 18.6%. (Edit: H2 FY 2024 corrected to H2 FY 2027, apologies for the typo).
Over the last four years, Cochlear has consistently achieved EBIT margins above 20% and ResMed has achieved EBIT margins above 27%. Therefore, I believe that it is not out of the question that PolyNovo could one day achieve better margins than I have modelled in the hypothetical illustration above.
In the illustration above, FY 2027 profit before tax would be about $32.7m and if we applied a normalised tax rate of 30%, then profit after tax would be about $22.9 million. In that scenario, at the current share price PolyNovo would still trade on a P/E multiple of 62.
As a result of this thought experiment, I certainly don’t think PolyNovo is obviously cheap right now at a share price of $2.07. However, that would not be an insane valuation compared to ResMed and Cochlear, which both trade on a P/E ratio of around 50.
So while one takeaway is that PolyNovo is not obviously cheap, I also don’t think its valuation is particularly hard to justify.
And if, for example, it earned 22% NPAT margins on $200m revenue in FY 2027 – a slightly better but still plausible result – then it probably would prove to be cheap at current prices.
Why I Like PolyNovo Shares
The main reason that I am tempted to buy a small amount of PolyNovo shares is that one of its main competitors, Integra Lifesciences seems like an extremely badly run company.
Most of Integra’s problems are self-inflicted. For example, in May 2023 the company issued a recall on NovoSorb competitor SurgiMend, then compounded the error by inadequately responding to violations that the FDA found at the company’s TEI Biosciences plant in Boston.
In the time since DeWitte took control, revenue has stagnated and company profits have been obliterated by writedowns. Net debt increased every single year and DeWitte leaves the company with ~US$2.4b of debt, about 50% more than when he inherited control
In a testament to the lack of leadership DeWitte was allowed to announce his impending departure in February 2024, and serve out the entire year. He finally left in December, but his successor will be crippled by a significant debt load, relative to EBITDA less Capex. Data per S&P CapIQ.
I can’t be certain, but I suspect that the incentives and culture at Integra are extremely suboptimal, and that they are therefore an ideal competitor for the relatively energised team at Polynovo. Of course, others might take a different view, and DeWitte himself recently said: “As I prepare to step down as CEO, I do so with a mix of pride and optimism. Well, I’m proud of our achievements over the past 3 years.”
In comparison, Polynovo is led by its chairman David Williams, one of the most remarkable market operators you will likely see on the ASX. The man is an absolute character, but you couldn’t accuse him of being anything less than sharp as a tack, and he owns over $40m worth of shares. He last purchased shares at about $1.60, but since that time, monthly sales have increased from ~$7m to ~$10m, a gain of around 40%.
In comparison, the share price is up about 30%, having closed this afternoon at $2.08.
While my concerns around valuation mean I must eschew the stock as an official recommendation, my inclination to weight my assessment of people over numbers and the fact that they have a great product makes me inclined to take a small speculative position.
David Williams says that “the surgeons are leading us into new markets we didn’t know were there,” and all the evidence I can find suggests it is a great product.
So that is why I like Polynovo.
Disclosure: The author of this article does not own shares in PNV and will not trade PNV shares for at least 2 days following the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Ethical Investment Advisers Pty Ltd (ABN 26108175819) (AFSL 343937).
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