Welcome to the next edition of Ask the analyst, where I put questions from Morningstar readers (and a few of my own) to our equity research team.

If you have a question about an ASX share or industry in our coverage, please send it to [email protected].

Today’s question

Today’s question came from Morningstar reader Simon. He wanted to know if AVITA Medical (ASX: AVH) is at serious risk of needing to dilute its shareholders in an equity raise, or even worse, risks bankruptcy given its continued losses.

We’ll get to what our healthcare analyst Shane Ponraj thinks in a moment. But first, a quick look at Avita’s business for those not familiar with the company.

Spray-on skin

Avita Medical’s RECELL system offers an alternative to skin grafts in the treatment of burns.

Avita’s solution takes a sample of the patient’s skin and recreates it in spray-on form within 30 minutes. Clinical trials showed that RECELL matches the healing ability of skin grafts without the large wound left by that approach.

RECELL has been around since the early 2000s but its commercial success was held back by it not receiving full FDA approval until 2018. This limited the ability for US hospitals to be reimbursed for it by insurers and government programs like Medicare.

Avita’s annual revenue rose from under USD 1 million in 2018 to over USD 64 million in 2024 as it made up for lost time. Revenue growth has not been the issue, though. The problem, as Simon pointed out, has been Avita’s cash burn.

Cash balance takes a beating

While Avita’s revenue has grown relatively quickly, its costs have grown far faster. To the point where selling, general and administrative expenses (which include staff and marketing costs) reached over USD 91 million in 2024.

These losses have drawn heavily on the cash Avita built up from a debt issue in 2023, listing in the US in 2021, and several private placements of equity. Avita’s cash balance has fallen from US 114 million in 2021 to under US 26 million as of its latest quarterly.

Compared to an annual operating loss of over 56 million in fiscal 2024, it is perhaps fair to see why markets may see another equity raise – or worse – around the corner. Our analyst Shane takes a more optimistic view, though.

Cash flow set to turn

Shane points to several reasons that cash outflows, which were roughly USD 10 million in the latest quarter, can be expected to improve. The main theme is that Avita has realised its need to cut costs until it is more profitable.

The company is now focusing on nine sales regions instead of the previous twelve, which has seen its sales headcount fall by a quarter. It has also announced that it will stop investing in its previous effort to become an approved vitiligo treatment.

Taken with the company’s reasserted guidance of hitting USD 100 million in annual sales during 2025, Shane thinks the company can be cash-flow positive going forward and record a net profit in 2026.

As a result, Shane does not expect Avita to need fresh equity financing – let alone go bankrupt. In addition to net cash and what he sees as an improving cash flow picture, Shane says that Avita has debt financing facilities available if needed.

Are the shares undervalued?

Avita’s ASX listed shares recently traded at around $1.50 each compared to Shane’s Fair Value estimate of $4.20. Why the big disconnect?

Shane thinks that markets are extrapolating Avita’s recent cash burn problems, despite there being room for optimism on this front. Longer term, he says the opportunity for RECELL remains attractive with potential for more use cases and international expansion.

For now, though, the US market remains absolutely key. Shane thinks that RECELL can grow its market share of treatments in the US’s 136 dedicated burns centres to over a third by 2026 thanks to the cost savings versus skin grafts for severe burns.

The opportunity in regular hospitals is tougher because the cost advantage against skin grafts disappears when you are treating less severe burns. The more fragmented nature of this market also makes it harder to go after in an efficient manner.

By the end of his five year forecast period in 2029, Shane thinks that Avita could be a $160 million revenue business generating $40 million in yearly net profit. A very different proposition, perhaps, to the Avita that we see today.

Broad range of outcomes

It is worth noting that Shane’s Fair Value estimate and forecasts comes with an Uncertainty rating of Very High attached to them. This means that Shane sees a broad range of potential outcomes for the company’s business and its shares.

A key source of uncertainty is Avita’s ability to deal with greater competition as various patents related to the RECELL system expire between now and 2036. Its systems are also rather easy to use and learn, presenting less of a switching cost to users.

Taken together, this could see Avita’s pricing power weaken and present a headwind to the margins it currently makes per use of the RECELL system.

Avita is also dependent on positive trial readouts and approval being given for further indications beyond adult and paediatric burns patients. As we saw with its attempt to gain reimbursement support for vitiligo, these things don’t always go your way.

Got a question about an ASX stock or industry?

Please email it to [email protected]. It may appear in a future edition of our Ask the analyst column.

Previously on Ask the analyst:

Get Morningstar insights in your inbox