Payer Scrutiny And Coverage Risks Will Limit Long-Term Precision Dermatology Potential

Catalysts

About Castle Biosciences

Castle Biosciences develops and commercializes diagnostic tests that use molecular and gene expression profiling to guide treatment decisions in dermatology and gastroenterology.

What are the underlying business or industry changes driving this perspective?

• The launch of AdvanceAD-Tx into a very large atopic dermatitis population could stall if payers are slow to establish coverage and reimbursement, limiting test adoption and capping the revenue contribution from what is currently modeled as a multibillion dollar opportunity.
• Despite strong clinician interest in precision dermatology, sustained payer scrutiny on high cost biologics and JAK inhibitors may incentivize restrictive coverage policies for new companion diagnostics, compressing long term pricing power and gross margins.
• If LCD reconsideration for DecisionDx-SCC fails to restore broad Medicare coverage, Castle could be forced to fund ongoing testing without adequate reimbursement or to restrict access, undercuting revenue scale and pressuring earnings from one of its core dermatology growth pillars.
• Rapid test volume growth in TissueCypher and the broader diagnostics portfolio is already driving higher personnel and lab costs. If operational efficiencies or pricing leverage do not materialize, the company may experience structurally lower gross margin and weaker net margins as it scales.
• Ongoing investment in expanded clinical evidence, FDA pathways and biomarker law positioning may extend cash burn in advance of clear commercial payoffs. This could elevate the risk that future earnings and free cash flow fall short of expectations embedded in a premium valuation.

Assumptions

This narrative explores a more pessimistic perspective on Castle Biosciences compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Castle Biosciences's revenue will grow by 3.4% annually over the next 3 years.
• The bearish analysts are not forecasting that Castle Biosciences will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Castle Biosciences's profit margin will increase from -3.6% to the average US Healthcare industry of 5.5% in 3 years.
• If Castle Biosciences's profit margin were to converge on the industry average, you could expect earnings to reach $20.7 million (and earnings per share of $0.66) by about December 2028, up from $-12.2 million today.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 55.6x on those 2028 earnings, up from -92.2x today. This future PE is greater than the current PE for the US Healthcare industry at 23.7x.
• The bearish analysts expect the number of shares outstanding to grow by 2.37% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.96%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The launch of AdvanceAD Tx into a 13.2 million patient moderate to severe atopic dermatitis population, combined with highly favorable physician intent where around 80% of clinicians surveyed plan to use the test, could create a durable new growth engine that expands Castle Biosciences revenue meaningfully over the long term.
• Sustained high growth in core franchises, with DecisionDx Melanoma volumes up 12% year over year, TissueCypher test volumes up 75% year over year, and total 2025 revenue guidance raised to a range of 327 million to 335 million dollars, suggests a secular adoption trend in precision diagnostics that could continue to lift revenue and earnings above currently bearish expectations.
• Growing and strengthening clinical evidence across DecisionDx SCC and TissueCypher, including multiple new peer reviewed studies demonstrating superior risk stratification and clear impact on management decisions, increases the likelihood of broader guideline inclusion and reimbursement wins, which could support higher long term pricing power and gross margins.
• Castle Biosciences continues to generate positive operating cash flow, with 22.6 million dollars of net cash provided by operating activities in the third quarter and a cash and investments balance of 287.5 million dollars, which reduces financing risk and provides capital to fund growth initiatives that may drive future earnings and net margin expansion.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Castle Biosciences is $30.0, which represents up to two standard deviations below the consensus price target of $38.75. This valuation is based on what can be assumed as the expectations of Castle Biosciences's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $50.0, and the most bearish reporting a price target of just $30.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $379.4 million, earnings will come to $20.7 million, and it would be trading on a PE ratio of 55.6x, assuming you use a discount rate of 7.0%.
  
• Given the current share price of $38.63, the analyst price target of $30.0 is 28.8% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.