Expanding In India And Innovating In Photon Technology Boosts Prospects Despite Challenges In China And Semiconductor Softness

Key Takeaways

• Expansion into India and focus on photon counting technology aim to recover market share in radiographic and dental sectors, potentially increasing revenue.
  
• Strategic emphasis on cargo inspection products and advanced CT systems in China indicates a long-term vision for revenue growth and market share expansion.
  
• The company faces challenges from declining sales in China, inventory adjustments, unfavorable sales mix, Asian competition, and costly joint ventures, impacting revenue and profitability.

Catalysts

Designs, manufactures, and sells X-ray imaging components.

• Expansion into India and advancements in cost leadership and innovation, especially in photon counting technology, which can recover market share in modalities such as radiographic and dental, thus increasing revenue and improving net margins.
  
• The resolution of supply chain challenges and inventory adjustments by customers expected to subside in early 2025, potentially leading to increased demand for medical products and contributing positively to revenues.
  
• Strategic focus on cargo inspection products within the Industrial segment, which has shown resilience and growth, could continue driving revenue upwards, given the strong global demand in security screening and cargo inspection markets.
  
• The softness in the semiconductor, electronics, and battery inspection markets within the Industrial segment is anticipated to be temporary. A rebound in these markets could enhance revenue diversification and growth.
  
• Despite current challenges in China, the long-term strategy to capture the shift in demand from lower-end CT systems to more advanced systems (64 and 128 slice CTs) in the medical imaging market could boost future sales and market share in China, affecting revenue positively.

Assumptions

• Analysts are assuming Varex Imaging's revenue will grow by 1.5% annually over the next 3 years.
• Analysts are assuming Varex Imaging's profit margins will remain the same at 4.1% over the next 3 years.
• Analysts expect earnings to reach $35.8 million (and earnings per share of $0.78) by about November 2027, up from $34.2 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $41.6 million in earnings, and the most bearish expecting $26.7 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 35.1x on those 2027 earnings, up from 16.3x today. This future PE is lower than the current PE for the US Medical Equipment industry at 35.9x.
• Analysts expect the number of shares outstanding to grow by 3.75% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.97%, as per the Simply Wall St company report.

Risks

• The ongoing anticorruption actions by the Chinese government have led to softness in sales in China, which could continue to negatively impact revenue from this significant market.
  
• Inventory adjustments by customers in the Medical segment due to increased levels during prior supply chain challenges could result in reduced demand for some medical products, affecting revenue and earnings in the near term until adjustments subside, expectedly in early calendar 2025.
  
• Unfavorable product sales mix, particularly in the Industrial segment with a higher proportion of lower margin cargo equipment sales compared to service sales, is pressuring gross margins, which could impact net margins negatively.
  
• Competition from Asia-based detector manufacturers, especially in lower-end modalities like radiographic and dental, poses a risk to market share and could lead to revenue losses or necessitate increased spending on cost leadership and innovation to maintain competitiveness.
  
• The company’s involvement and higher losses associated with joint ventures such as dpiX and investment in Micro-X have led to unusually high expenses affecting overall profitability, indicating potential risks in investment returns that could impact earnings.

Valuation

• The analysts have a consensus price target of $22.2 for Varex Imaging based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $30.0, and the most bearish reporting a price target of just $16.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $871.9 million, earnings will come to $35.8 million, and it would be trading on a PE ratio of 35.1x, assuming you use a discount rate of 8.0%.
• Given the current share price of $13.62, the analyst's price target of $22.2 is 38.6% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• 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.