Alex Milton, Principal and Co-Portfolio Manager
NovaPort initiated a position in Nanosonics earlier this year.
Founded in 2001, Nanosonics designs, manufactures and markets high level disinfection equipment for the health care sector. Full year sales for the 2016 financial year are up over 90% (to $43m) and the last two quarters has seen positive cash flow adding to a substantial cash balance net of very little debt.
Its flagship product, the trophon® EPR disinfects ultrasound probes used by medical professionals for diagnostic assessment. The technology is based on nebulised mist of hydrogen peroxide applied to devices to destroy microorganisms.
The company generates revenue through the sale of disinfection units. While product sales generate a high margin, they are one off in nature (or at least until the customer decides to replace old with new and assuming they don’t switch to a competitor’s product). Meanwhile however, once trophon® is installed the ongoing sales of hydrogen peroxide cartridges earn healthy margins and very predictable by nature.
Nanosonics investment appeal lies primarily in its global opportunity to expand sales materially over the years ahead thereby building on its already dominant position in Australia.
While it’s easy to find companies listed on the ASX with global opportunities, the number of candidates for the fund falls away quickly when it comes to assessing real and sustainable competitive advantage.
In this case we can point to a number of factors that give us the confidence to forecast solid growth over the longer term.
1) Early days for global expansion but favourable trend is already evident
There are over 500,000 disinfection units currently installed worldwide. While its push into international markets is still in its relatively early stages, Nanosonics has established a demonstrable track record of sales in the US and Europe with 10,000 units currently installed globally.
Quarterly updates continue to show growth above our expectations in the all-important US market. As at the end of the June quarter, the company had 8,700 installed units in the US and growing rapidly so we still see significant upside as market share grows off a low base.
2) In house expertise from design to end user sales mitigates third party supplier risk
Nanosonics has in house expertise and control of product design, development, manufacture and marketing and is not dependant on third party intellectual property or a licence which is a risk should supplier relationships deteriorate.
3) Increased scrutiny and more stringent regulatory guidelines works in their favour
The level of scrutiny and regulation by government authorities and insurance companies to mandate stringent guidelines on acceptable methods of disinfection is only increasing given the incentives to lower rates of hospital acquired infections. The next major market expected to issue guidelines that would likely support trophon® sales is the UK.
Increased regulatory intervention will benefit Nanosonics given trophon® has established its credentials as a robust high level disinfection solution. In addition, trophon® disinfection currently stands out as the most effective means of combating inadvertent transmission of cancer causing HPV (human papillomavirus) via cross contamination through the use of ultrasound probes.
From an environmental health and safety perspective, the major agent in the disinfection process is hydrogen peroxide which is nebulised and applied to the probe at low temperature. Unlike other methods which apply harsh chemicals for disinfection and then require safe disposal, trophon® by product is effectively just steam.
Risks to consider
There are a number of risks that we will monitor going forward regarding our investment in Nanosonics:
- Currency. With the US becoming a bigger source of revenue with each quarter, the exchange rate will have a bigger bearing on translated profits.
- Product. Healthcare facilities rely on disinfection equipment to eliminate transfer of infections between patients and staff or at least reduce the risk to an acceptable level. Infection transfer attributable to product failure would potentially be a significant issue.
- Competition and technology. Very positive trends in customer adoption rates to date validate trophon®’s branding as one of the better solutions in the market for high level disinfection. However, competition is strong and the risk of alternative products replacing trophon® or technology rendering it’s offering redundant needs to be monitored.