A few more quarters have passed, but nothing has really changed for the good at axogen (AXGN), as the company continues to struggle to gain traction with its nerve repair products (Avance in particular). While explanations such as disruptions and delays due to COVID-19 are valid up to a point, the reality is that the adoption curve did not match expectations even before the pandemic, and much more depends on the next reading of the company’s RECON study- out.
While I continue to believe in the clinical case for Avance and allograft nerve repair, the reality is that changing the way surgeons practice is difficult and time consuming. Axogen has invested a lot of resources in training surgeons, but clinical data (namely the RECON study) is probably the best chance Axogen has to change opinions and practice. After being down almost 50% since my last update, I’m still bullish on Axogen based largely on the results of the RANGER and MATCH studies, but this stock is only suitable for aggressive investors who can accept biotech-like binary results.
COVID-19 blamed for another expectation reset
Axogen reported a 3% decline in sales in the fourth quarter, with case volume down 8% and a modest 5% improvement in price and mix. The cause of the weakness is not new, with management pointing to COVID-19-related procedural postponements and hospital staffing issues. I would note that there was a modest sequential improvement in the quarter ($31.5m vs. $31m), likely on price, despite increased pressure on hospitals in Q4 since the start of the Omicron Surge.
Gross margin fell 40 basis points in the quarter, beating expectations by 10 basis points. Operating expenses were lower than expected, but lower operating losses aren’t really stock movement events for unprofitable small-cap medtech.
With the impact of With Omicron’s push extending into the first quarter and ongoing hospital staffing issues, management lowered its guidance again, with FY22 revenue guidance of $135 million to $142 million from an average estimate of $144 million. In the interest of additional perspective/context, the sell-side expectations for FY22 exiting Q3 2021 were approximately $148 million with a range of $139-154 million.
The bear’s interpretation of all this is pretty straightforward – allograft nerve repair with Avance isn’t popular enough with surgeons (and may never be), and Axogen has far outnumbered surgeons. interested in performing the procedures. While the pandemic has impacted a range of surgeries, Integra LifeSciences (IART) achieved 4% year-over-year organic growth in the quarter – not a perfect mix, but still worth considering.
Bulls can refute on a few lines. First, the delays related to COVID-19 are real, and although the results of trauma-related nerve repair are better the sooner the procedure is performed, nerve repair can in most cases still be performed for up to a year after the injury (not as true for Integra’s wound care business). Second, there has certainly been a drop in breast reconstruction and surgical pain management cases due to the pandemic, and these also represent a potential future backlog of cases. Additionally, Axogen has seen continued growth in active and lead accounts and continues to grow its sales force.
RECON has always been important, now it seems critical
As investor frustration and disillusionment with Axogen’s lack of progress grows, the next reading of the RECON study is now key for sentiment.
The RECON study was initiated to support a BLA filler for Avance with the FDA and if successful, Avance would be the reference product, giving Axogen 12 years of market exclusivity. If this fails, there is a risk that the company will no longer be authorized to sell Avance.
RECON was designed as a non-inferiority study comparing Avance to engineered conduits, but Axogen must demonstrate superiority (a secondary outcome) to cause real sentiment change. The results of the RANGER and MATCH registration studies suggest that superiority shouldn’t be an issue, but the market is clearly nervous, and it’s also clear that the RANGER and MATCH results weren’t enough on their own to drive a significant change. in surgical practice.
Although RECON’s results are overwhelmingly positive for Avance and Axogen, investors should not expect an immediate shift in sales or adoption. When faced with new techniques/products, it is common for surgeons to conduct their own “trials”, perform a small number of cases, and then track the results before making a broader change to their practice. So while it’s true that Axogen’s active account base of 951 and master account base of 294 are small compared to the over 5,000 installations that could be using Avance, even an optimal result for RECON will not lead to a change in practices overnight.
In addition to the efficacy risks covered by the RECON study, there are at least two other potential risks with Axogen to consider: that the markets are not as large as the company claims and that the company’s marketing efforts company are not up to the task.
Management talked about a $1.9 billion trauma market, and that’s a hard number to corroborate, but I think it can be believable. Putting together available information from literature searches, it appears that there may be approximately 16 million trauma-related admissions in the United States per year, with incidences of nerve damage ranging from approximately 1.5% to lower limbs to 3% for upper limb cases. With an average procedure cost of around $4,000, I can access a $1.6 billion trauma market.
Beyond that, there are opportunities in breast reconstruction, oral/maxillofacial, carpal tunnel, and surgical pain management (post-hip/knee replacement pain, etc.), and I think so that the market opportunity here is believable, but I will repeat that there are a lot of assumptions in these calculations, and it is not difficult to get a much smaller addressable market.
When it comes to the company’s marketing efforts, the ability to attract and retain sales reps is positive, as is the growth in active/prime accounts, but clearly there aren’t enough surgeons who use Axogen grafts quite often. At best, this is considered “incomplete” pending the outcome of the RECON study and seeing how Axogen benefits from it if the results are positive.
With the continued challenges of the business, I’ve essentially pushed my model back another year. If Axogen achieves my goal of $134 million for this year, that will represent compound growth of approximately 8% from 2019, and I expect acceleration to approximately $280 million in 2026 and growth in mid-teens in the next five years. All in all, if RECON is successful and Axogen can successfully market through it, I expect long-term revenue growth of over 16% from 2021, and I think Axogen could attract teenagers medium to tall. FCF margins to over $500 million in revenue.
Looking at valuation through discounted cash flow and growth-oriented EV/income multiples (a common way to value medtech stocks, especially loss-making companies), I can still support a fair value medium to high for teens on Axogen, with the high end based on a 5.7x multiple to my earnings estimate of 22. That’s a significant upside, but it also comes with significant risks. While I believe the RECON study will be successful, Axogen’s ability to execute has yet to be proven and these stocks are still only suitable for more aggressive investors who can accept the risk of greater losses. .