The new medical device company to watch

-- | 28/02/2020

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Glenn Freeman: In this earning season update, we're speaking about healthcare stocks, and I'm joined today by Nicolette Quinn from Morningstar equity research.

Nicolette, thanks for your time.

Nicolette Quinn: Thanks, Glenn.

Freeman: Now, Avita is a stock that we've just started coverage on earlier this month. And it's a 4-Star stock. So, it's trading at quite a discount to what you believe it's worth. What's behind this?

Quinn: We think the company has a very compelling product. So, it has a system that it calls RECELL. And what that's able to do is create spray on skin to treat a burn wound within about 30 minutes. Now, for decades, burn wounds have been treated by skin grafts. But we think of Avita's product has a really good chance of being a challenger to become the new standard of care in treating burns. It's very early in the commercial ramp up, but when we look at the results, we can see signs of early traction.

Freeman: And why is it at such a discount? Are investors underestimating or overestimating something?

Quinn: I think there's a lot of uncertainty because it's so early in this ramp up phase about how things will actually play out.

Freeman: Now, it doesn't have an economic moat. Have you chosen not to put a moat on this stock?

Quinn: We look at the main thing around medical devices, which tends to be intellectual property. And for Avita, one of their key patents actually expires in 2024. And although the company are pursuing quite a few avenues to extend the protection of their property, there's no certainty that they will actually have protection beyond this date. And so, we can't actually apply a moat in this instance.

Freeman: Sure. And moving on to a different stock and it's one that our investors will probably know quite well is CSL, a blood plasma firm. Now, that sits at the other end of the valuation scale. It's around 40 per cent above what you believe it's worth. So, what's happening here?

Quinn: I think I want to start off by saying that we're not negative at all about the near-term prospects for CSL. So, our view on earnings certainly over the next two to three years is not different from the market. However, we see risks to the plasma industry as a whole that we don't think are priced into CSL. So, the type of things we're looking at are products that can essentially replace plasma products in treating the same therapies. One example of this is recombinant products, which don't require plasma as an input and another one is gene therapy. So, that could actually cure rather than treat a disease. Where we see an example of this actually playing out already is in the hemophilia segment within CSL. So, plasma products are in decline. Recombinant products have taken over and there are other players actually arriving in that market that are not plasma players that are now dominating market share. There's also a gene therapy to treat hemophilia A, which we're expecting to actually be approved within the next two years.

Freeman: So, what's the story behind the share price being so overvalued at the moment?

Quinn: I think people are projecting what they see in current in the very near term just further and further out without taking cognisance of these risks.

Freeman: Looking across both of these companies, and indeed, I think all the other healthcare stocks that we cover, the US is by far the largest market. How does the U.S. exposure for these stocks factor into your analysis?

Quinn: Well, the US is the most valuable healthcare market in the world. But it's also very opaque, particularly when it comes to pricing. And we think about a lot more than just currency. What a product needs to be commercially successful is it needs to actually have payers being willing to reimburse and pay for the product. And this is where the political sphere feeds in. So, whether it'd be payer from Medicare or the private health insurance market, all of those are really factors that we think about and how that feeds in to ultimate commercial success of products.

This report appeared on 2022 Morningstar Australasia Pty Limited

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