Nanosonics' June quarter update proved a positive surprise but most brokers cannot get past the many risks, also finding the shares look expensive.

-Nanosonics' Q4 sales beat market expectations, brokers upgrade price targets
-New direct sales channel implemented
-Full earnings results and R&D update to be reported on 23 August
-Risks ahead without GE as commercial partner

Transition to new business model looks successful

Analysts have welcomed a positive trading update from medical device company Nanosonics ((NAN)), with revenue for FY22 expected to be $120.3m -- 17% higher than the previous financial year -- beating expectations and raising confidence the company has transitioned smoothly to a new sales model.

However, while many have lifted their price target for Nanosonic, views are mixed on the outlook for the company and the risks ahead.

Nanosonics provides infection prevention solutions and materials, with significant numbers of clients among hospitals in the US and Europe. The company said this week its transition to a revised sales model in North America has been substantially completed with a significant proportion of sales now going through a direct sales channel.

Under a revised business model, all of GE Healthcare's existing Trophon disinfection device customers will transition to Nanosonics for the ongoing provision of consumables.

Nanosonics had previously advised GE Healthcare would transition from a distributor of the Trophon device to a re-seller and that the company would expand its own US workforce to become the sole distributor of both the re-agent consumable and hardware.

The changes, announced earlier this year, had raised concerns of a slowdown in Nanosonics' sales, but this week's update has allayed those fears, while also removing some uncertainty about a revenue gap emerging in FY23 and beyond.

Direct customer access seen as a positive

One of the most upbeat on the company's outlook is Canaccord Genuity.

With a previously announced one-off hit to revenue from the GE transition process, the broker highlights "revenue has still managed to improve 17% year on year, which is a commendable performance."

With direct access to its customer base, the broker sees potentially significant operating leverage on the horizon. In addition, given Nanosonic's heavy investment in the EU market through the pandemic, Canaccord is bracing for a meaningful improvement in revenues from the EU region.

In response to the pleasing market update, Canaccord has lifted its price target to $4.89 from $4.78 and retained its Buy recommendation.

Wilsons, too, is confident about Nanosonics' prospects. While management at the company expects a second half revenue impact of -$13m to -$16m from changes to the business model, Wilsons finds confidence in the observation that Nanosonics has executed well, reducing the threat of a revenue "hole" in the months ahead.

Wilsons has maintained its price target at $7.00, including prospective R&D assets.

Nanosonics is scheduled to report full year results on 23 August, together with an update on R&D, which, analysts say, will be important for the market to understand the clinical and regulatory progress of the Coris endoscope decontamination device program, and other product launches.

What about the valuation?

Nanosonics may have surprised positively with its June quarter performance, this does not stop some brokers from calling the shares overvalued.

One such broker is Citi, whose target price increase does not reach further than $3.85, up from $3.65 prior. No surprise thus, with the shares trading above $4.00, Citi analysts have maintained their Sell rating for the stock.

One obvious impediment for Citi is it does not expect the company's earnings per share (EPS) to rise above FY19 levels until FY25, and nor is Nanosonics expected to report a material profit until at least FY25.  

The biggest risks, according to Citi, are that the Trophon device takes longer or fails to gain traction in emerging and Asia Pacific markets and that new products fail.

Bell Potter too is doubtful about the stock's potential to sustainably rise further from its current price level.

Bell Potter considers Nanosonics fully valued, with the current share price already assuming significant value from the R&D pipeline. Bell Potter's has maintained its Hold rating, with its price target increasing to $4.05 from $3.95 on the positive sales result.

While guidance didn't cover earnings, Bell Potter now expects Nanosonics to post an operating result close to breakeven for the full year.

Goldman Sachs shares the view that Nanosonics shares look overvalued. This broker's price target currently sits at $3.20.

Beyond the positive sales result, Goldman Sachs continues to point at significant risks on the horizon. In particular the loss of GE, the leading global ultrasound manufacturer, as a commercial partner may challenge the penetration of the company's products and sales.

Irrespectively, Goldman Sachs cannot get past the elevated earnings multiples, which seem an anomaly given the degree of risks surrounding the company's outlook. Goldman Sachs has reiterated its Sell rating.

Joining the chorus of brokers believing Nanosonics shares are overvalued is Ord Minnett. A lack of growth in markets outside the US leaves this broker cautious. Following the sharp recovery in the share price over the past month, Ord Minnett has maintained its Lighten recommendation, with its target price increasing slightly to $3.70 from $3.50 due to upgrades in earnings forecasts.

According to FNArena's database, the consensus target price for Nanosonics is $4.14, suggesting -8.3% downside to the last share price. All of Goldman Sachs, Wilsons and Canaccord Genuity are not included in FNArena's consensus calculations.

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