On Monday, Tristel plc published its final results for the year ended 30 June 2021. I previously covered Tristel plc in February, when the company was trading at 50x 2021 earnings. In this prior article, I was under the impression that little had changed in Tristel’s prospects since 2019, and that although Tristel was a quality business with superior financial metrics, I would be placing the company on my watchlist, as it was a tad too expensive for my liking.
The shares are now down 7% since the results on Monday, yet they are trading at 58x trailing earnings (and approximately 48x forward earnings in 2022). In this article, I will provide an update on the company and try to understand why, during the biggest contamination crisis in recent history, its revenues have fallen.
Tristel has been in operation since the 1990s, however, it was only listed on AIM in 2005. Its business is focused on preventing the transmission of microbes from one object or person to another in order to stop the cause of infection in humans. The business targets hospitals, as this is where the risk of infection to individuals is the highest. Its products use chlorine dioxide in order to disinfect both medical devices and surfaces, the use of which is its primary selling point and what differentiates it from other competitors in the sector.
Their business was previously segmented into four main segments:
Tristel: the core business, focused on medical device decontamination using chlorine dioxide technology
Cache: surface disinfectants and decontamination using chlorine dioxide technology
Anistel: infection prevention for the animal healthcare and veterinary industry
Crystel: lab and pharmaceutical disinfectants
However, in their 2021 final results, the company’s chairman detailed Tristel’s objectives to discontinue many of the products that they currently consider to be non-core (in both the Anistel and Crystel segments) as they are lower margin than Tristel and Cache and draw disproportionately on the company’s resources. The business will now focus on Tristel (which accounted for 77% of global sales in 2021) and Cache (which accounted for 13% of sales).
Tristel differentiates itself from its competitors through its use of chlorine dioxide in its disinfectants:
“[W]e are the only provider of chlorine dioxide-based high-level disinfectants validated and regulated for use with semi-critical medical devices; and [...] we are unique in applying the active ingredient in a manual process.”
Tristel explains that this manual application, compared to other disinfection processes which require automated equipment, means that they are “the simplest, quickest and most affordable high-performance disinfection method available”.
The table below shows the performance of both the Tristel and Cache segments in comparison to their performance in the year ended 30 June 2020. Tristel's (the core business) revenues grew 2% to £24m, but were held back by poor performance in the UK channel, which serves the NHS. Overseas business was good, but with growth of only 10% in this segment, it wasn’t enough to offset the weak performance in the UK.
Their much smaller business unit Cache, which houses the surface disinfectant business, really struggled. Flat sales in the UK and sales down 43% overseas suggest Tristel’s Cache product hasn’t lived up to what the company originally targeted for the product.
In my article earlier this year, I voiced skepticism at Tristel’s ability to grow in their Cache surface cleaning segment, as I believed other solutions such as bleach or industry standard disinfectants would be the go-to cleaning solution, as surface cleaning isn’t required to have the same level of rigorous quality that medical devices require. I think these results show this to be true, and I would potentially expect the Cache segment to be wound down or divested in the coming years if sales continue to struggle.
Competitors and Risks
Looking at the medical device cleaning segment, Tristel operates with almost no direct competitors. However, when evaluating a potential investment, we have to conceptualise competition in a different way. In my opinion, the real competition for Tristel is a scenario in which disposable medical equipment becomes more prevalent than reusable medical equipment.
Companies like Ambu, a leading Danish medical device company who specialise in single-use devices that are discarded at the end of procedures, risk taking market share from Tristel. Rather than having to clean devices at the end of surgical procedures — an intensive process that must be performed stringently due to the high risk of cross-contamination — Ambu’s offering in a post-Covid world may seem more attractive. Single-use or disposable equipment may also be more attractive if the price to purchase reusables is less expensive than the cost of the stringent cleaning and maintenance of equipment.
During the past ten years, Ambu has spearheaded the establishment of single-use endoscopy as a clinical practice and they have recently expanded into other areas of endoscopy. In 2019/20, they launched three new devices, and they have a comprehensive pipeline of single-use endoscopes to be launched in the coming years. They estimate that the single-use endoscopy market will reach USD 2.5 billion by 2024, and they aim to be the market leader in this segment.
Picturing a world where easy to discard, impossible to contaminate, single use medical devices are more prevalent would provide a real headwind for Tristel in the coming years.
However, to return to the side of Tristel, we do need to be cognisant of entering an environment where reducing medical waste is becoming a key focus. The amount of PPE equipment that has been thrown away due to the pandemic could begin to mount on government regulators and create pressure to increase the re-use of medical equipment through stringent hygiene protocols, thus improving the picture for Tristel.
As seen in the financial table above, Tristel plc experienced a steep decline in revenue growth in 2021. In the four years prior to 2021, the company had been growing at a mean average of 16.75%. This reversal in growth in 2021 (at -2.1% from 2020) was partly explained by the pandemic causing hospitals worldwide to curtail the number of patient examinations, which resulted in less demand for Tristel’s medical devices to disinfect products. This decline can also explained due to the decline in contribution to revenue growth from the Cache segment of the business.
Looking at gross margin, the company was able to remain at around the 80% mark. However, their operating margin fell to its lowest point in the last five years at 15.4%, dropping from the mean average of the prior four years of 19.1%. This drop in percentage was explained by Tristel as partly due to the regulatory environment in which they operate changing rapidly — disinfectant products in hospitals are now classified by regulators as “medical devices”, which means that they are put to the same rigorous standards as any other medical device, such as surgical implants. A further reason for the drop in operating margins was due to an audit to the company performed in March 2021. This audit revealed “certain weaknesses” in relation to “quality assurance and regulatory functions”. This audit resulted in Tristel bringing in specialist consultants and directing “all the resources of the Company to redress the weaknesses identified”, thus affecting their costs for the year.
Their return on capital employed (ROCE) also fell to its lowest point in the last five years. This isn't great considering Tristel has faced a general downtrend in ROCE over the last five years. In fairness, this result could be addressed by the wind-up of non performing business units (such as the Crystel and Anistel product lines) that Tristel has identified their intention to cut loose. However, with an underperforming surface cleaning business also in the mix, I don't foresee ROCE bouncing back quickly.
Conclusion and Valuation
In summary, since February 2021 when I first covered the company, Tristel still looks very expensive at approximately 48x forward earnings. However, the difference now is that revenue growth has showed signs of slowing. Some may say that Tristel has missed opportunities to clean up during the pandemic, and its margins have certainly started to sour. This souring is also reflected in its ROCE, which over the last five years has consecutively declined. With all this considered, in my opinion, Tristel no longer deserves its premium rating, and I won’t be investing.
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