DexCom: Attractive Discount After Strong Earnings Results (NASDAQ:DXCM)

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I believe that DexCom is undervalued and that a price correction could occur within the next 12 months for the following reasons:

• Manufacturing Consolidation – I believe DexCom has the ability to slash manufacturing costs as they transition users of all products to G7-based products, which could cut their cost of sales by up to 20% in FY 25
• Stelo Launch – DexCom’s type 2 over-the-counter product Stelo was recently approved by the FDA and is expected to hit the market in the summer of FY 24, which will provide a new revenue stream for the firm.
• Increased Patient Coverage – The company should see more coverage for 25 million Type 2 Diabetics and 98 million Prediabetics in the United States in 2025, compared to the 2 million Type 1 Diabetics DexCom currently targets.

Shares of DexCom (NASDAQ:DXCM) were down roughly 8% in after-hours trading after the firm announced solid first-quarter results. To summarize, EPS weighed in at $0.32 cents per share, beating analysts’ consensus of $0. 27 cents per share. Revenue also slightly edged out expectations at $921 million, compared to the Street’s expectations of $910 million.

CEO Kevin Sayer claimed this success was largely due to growing demand from individuals experiencing coverage increases. Sayer then raised guidance for annual revenues to the lower bound for a new range of $4.2 to $4.35 billion, as opposed to the prior range of $4.15 to $4.35 billion.

There is significant upside to be seen at the current share price given the imminent launch of DexCom’s type 2 over-the-counter product Stelo, which was recently approved by the FDA. DexCom plans to bring the new sensor to market in the summer of 2024. This will allow DexCom to tap into a new market of 25 million Type 2 diabetics who are not currently on insulin, as the company has confidence with its expanded sales force that it will be able to gain market share quickly.

Why the Fall?

If you are curious, why the price declined despite beating expectations and optimistic announcements for forward guidance, it may have to do with timing. At the end of the call, Wall Street analysts expressed concerns over the plan to launch Stelo in the summer of 2024, even though the infrastructure and, more importantly, FDA approval for the product have already been established. Sayer says that while molding, packaging, manufacturing, and regulatory compliance have all been completed, there is “no rush” to launch the product early. Sayer reassured sell-side analysts that there are many inquiries of interest among potential buyers and that they anticipate “strong demand”.

Another concern analysts expressed during earnings was over the road to a 15-day sensor wear, which could elevate gross margins with one less sensor in each shipment. A further question raised pertained to patterns in market share growth in the basal market for individuals who only require long-acting injections of insulin, as opposed to active insulin therapy. A third issue to note would be a potential delay in revenue growth from a transition towards direct-to-consumer in Japan until the latter half of the year.

Any number of these risks mentioned during the call could have led to the diminished price after the announcement, but a review of some key catalysts presented by management supplemented with fundamental analysis tells a story of long-term price accretion for the stock.

Reading Between the Lines

While there may have been some concerns over no early launch for Stelo, Sayer made some strong evidence that sustained revenue growth is here to stay. As mentioned, revenue is increasingly coming from those who are first-time receivers of coverage for DexCom products, such as a “good chunk of patients” coming through their basal channel. It can also be inferred that younger demographics are becoming a more significant portion of DexCom’s market share, as Sayer remarked that many young patients are walking out of the hospital with DexCom’s immediately after diagnosis. Combining this with the new ability to use an Apple Watch as a primary display, parents should be able to integrate their children into DexCom’s ecosystem early on in the diabetic life cycle and avoid concerns over phone access at a young age. Prior to this approval from the FDA, it was a requirement to use a cell phone to share DexCom data with parents. While revenue drivers are important and should add to the top line in coming years, the real jump in share price is likely to come from streamlining manufacturing as DexCom prepares to launch Stelo this Summer.

Seeing the Opportunity

Despite some concerns from the market, the company is confident it will be within the guided range of revenue growth for the year, and I, personally, believe it will sit on the upper end of its range at 21% given its history of capitalizing on expanding their sales force. In 2021, they made a similar expansion to their sales force, increasing operating expenses by 14% but leading to an even more impressive revenue growth of 27%. However, there is high potential for a massive jump in 2025 due to transitioning most G6 users to the G7 platform, anticipated extended coverage, and capitalizing on manufacturing synergies.

DexCom will likely be able to reap the rewards of streamlining their manufacturing process as they transfer G6 users to their G7 product, as well as transitioning their international DexCom One customers to a new version that also relies on G7 hardware. Another important point to mention with the launch of Stelo is that they will have yet another product that relies on the G7 platform. While analysts and management alike seem to think most of this consolidation will occur in 2025, it is fair to assume that their gross margin may be slightly higher as the streamlining process commences later this year.

The Assumptions

The company announced results largely in line with market expectations, so my forecasts for future periods have not been updated. I see Stelo entering the market in the summer of FY 24, based on company-disclosed announcements. This contributes to larger revenue increases in future periods. I believe revenue will grow to ~$18 billion by FY 33, well ahead of consensus estimates. Annual results for FY 24 will largely be in line with company guidance, but FY 25 revenue may come in ahead of company guidance and consensus estimates. FY 25 revenue largely depends on the market for Stelo, as well as increased coverage for type 2 diabetics and prediabetics.

I see massive potential for margin expansion going forward, as DexCom expects to streamline all manufacturing operations as they transition more G6 users over to G7, work towards a 15-day sensor life as opposed to the current 10-day life, and convert the DexCom One to depend on the G7. In terms of operating expenses, it seems the company expands its sales force once every three years (2021 and 2024). I believe this trend will continue in the future.

Assumptions:

Revenues – I expect revenue growth to be 21% in FY 24, given the company’s guidance. In FY 25 I anticipate a larger 30% growth in revenue, considering expanded coverage and Stelo revenue contributions. By FY 28 I expect revenue growth to slow to 15%, which is lower than their historical average.

Cost of Sales – Rises in FY 24 as they are manufacturing multiple sensor types, and drops by 20% (as a & of revenue) in FY 25 due to the streamlined manufacturing process.

Operating Expenses – In years when the firm does not expand its sales force, I assume the firm can decrease its operating expenses as a % of revenue by 10%, which is approximately how much they have done so in the past. For years when they do expand their sales force, I anticipate it will be by 13.5%, the amount they increased operating expenses as a % of revenue in FY 21 when expanding their sales force.

Comparable Companies

I do not view Comparable Companies Analysis as a meaningful methodology for DexCom, but, nevertheless, the selected set is shown below:

The DCF

I have forecasted DexCom’s P&L as follows:

I then calculated Unlevered Free Cash Flow as follows:

Assumptions:

Discount Rate: 8.60%, based on the firm’s capital structure, WACC for comparable public companies, and targeted capital structure in line with comparables.

Terminal Value: Long-term free Cash Flow Growth Rate of 0%, or, alternatively, a Terminal EBITDA Multiple of 12.0x.

Other: End-of-year Convention used

The Output

As a result of the dwindle in price, the market now values DexCom at $55 billion in equity value. Adding debt & financing leases and subtracting out the company’s cash converts this to an enterprise value of around $57 billion. I see an 8% upside buying into the stock today given my base-case assumptions. My target share prices are as follows:

Bull Case: $183.71, based on revenue, cost of sales, and operating expenses FY 24 growth rates of 17%, 17%, and 11%, respectively, through FY 33.

Base Case: $133.80, based on revenue, cost of sales, and operating expenses CAGRs of 16%, 16%, and 13%, respectively, through FY 33.

Bear Case: $87.37, based on revenue, cost of sales, and operating expenses CAGRs of 14%, 14%, and 15%, respectively, through FY 33.

What are the Risks?

The following represent the greatest risks to My investment thesis:

1. Greater Tailwinds in Revenues from Stelo Launch and Japan Direct-to-Consumer Transition – It is possible that revenue increases from the Stelo launch and transitioning Japan to Direct-to-Consumer do not occur until FY 26 or FY 26, which would make it difficult for DexCom to grow revenues by 21% and 30% in FY 25 and FY 25, as I have assumed.
2. Delays in G7 Form Factor Manufacturing Synergies – Similar to the delay in revenue increases from the Stelo launch, it is possible that any one of the following could occur: Delay in transitioning G6 users to G7, delay in launching Stelo, delay in transitioning DexCom ONE to G7 form factor, delay in development of 15-day sensor life. If one or more of these events occur, this could decrease operating leverage in FY 24, FY 25, and FY 26.
3. Lack of Coverage for Type-2 Diabetics and Pre-Diabetics – While I anticipate extended coverage for Type-2 Diabetics and Pre-Diabetics in 2025, it is possible that coverage is delayed, or does not occur at all. The delay or lack of coverage would lower revenue growth rates in forecasted years.

Conclusion

In light of this DCF analysis, I am confident DexCom could see a price rise within the next 12 months. It would be wise to buy now with the stock sitting on the lower end of its 1-month range. To provide some ideas for a time horizon, keep an eye out for news regarding Stelo as the product launches this summer. Additionally, I will be watching how the transition to 15-day sensor life for the G7 series plays out, with hopefully an announcement coming in the latter half of this year or early next year. Finally, I would pay attention to Q4’s earnings release in particular, as I anticipate favorable guidance for next year with an anticipated expansion of coverage for Type-2 and Prediabetics, as well as the expectation that Stelo will truly begin to contribute to DexCom’s P&L.