The expectation is to reach a gross margin of 25% in 2025, but if it were reached in 2028, the shares could more than double according to my estimates.
After a few complicated years with revenue that didn't grow as much, a gross margin that was even negative and numerous changes in CEOs, Mr. Mark Strobeck arrived at Rockwell Medical (NASDAQ:RMTI) in 2022 to completely turn around the situation and currently it has even reached the first quarter net income profitable, something unthinkable a few years ago.
If the expectation is met and the gross margin expands to 25% from now to 2028 (the expectation is that it will be reached in 2025), the stock could more than double, making it a buy opportunity in my view.
Rockwell develop concentrates for hemodialysis, which is a process that seeks to artificially replace kidney function in patients with chronic failure. Then, the patient would use the concentrates to, from home, prepare the mixture for their dialysis and thus cleanse their blood, which is one of the key functions of the kidneys.
There're different ways to end up needing dialysis, like having chronic diseases such as diabetes or high blood pressure, infections or kidney injuries, and even alcoholism can accelerate these failures. Whatever way this point is reached, these treatments are usually done recurrently and in cases of chronic kidney failure, hemodialysis may be required three times a week or more. So these are life-sustaining essential products.
It's estimated that chronic kidney disease affects more than 37 million adults in the U.S. and there're nearly more than 800,000 Americans living with end-stage renal disease, of whom almost 70% are on recurrent dialysis.
Despite being a critical and indispensable product for Rockwell customers, there's currently no large competitor dominating the category. In fact, despite being a company on its way to $100M in revenue (a small size), Rockwell is already the largest supplier of bicarbonate concentrates and the second largest in acid and dry bicarbonate concentrates, evidencing the opportunity it has to lead the market and benefit to later expand its range of products, which has been a plan of the CEO for some time.
I believe that in order for us to stabilize and grow our business, we need to drive profitability in our hemodialysis concentrates business to continue to explore opportunities to develop alternative settings and support our international expansion.
CEO Mark Strobeck on Q2 2022 Earnings Call
As I mentioned previously, the current CEO arrived recently, after a few turbulent years of constant changes of managers. Robert Chioini founded the company and held the position until 2019, to be replaced by Stuart Paul who lasted a few months until 2020 to be replaced by Russell Ellison and then current CEO Mark Strobeck finally arrived in mid-2022.
We can realize the chaos that existed in the company in recent years after Mr. Strobeck arrived. The company had accumulated a period of six years where the gross margin didn't exceed 6% (it was even negative in FY2021) and sales didn't grow more than 10% on that timeframe (-0.5% in FY2021). Upon his arrival, he made a strategic review to improve profitability and thanks to that during FY2022 revenue grew almost 18% with a gross margin of 5.6%, FY2023 grew 15% with a margin of 10.4% and during Q2 2024 the gross margin reached 18%. In addition, the Q2 2024 was net income profitable, something unthinkable a few years ago.
Understanding the great change that the company had numerically after the arrival of the current CEO is important to evaluate if we can believe the current plan. By FY2025 the company expects to reach a gross margin of 20% and in subsequent years the idea is to reach +25% while revenue grows at mid-to-high single digit.
As I mentioned, being two quarters away from finishing FY2024 and four quarters away from finishing FY2025, Rockwell have already reached 18% of the 20% gross margin target. That gives us an idea that we do have reasons to believe in this expectation.
During Q1 2024 sales grew the guidance of 15% YoY, but during Q2 2024 this growth was 42.5%, suggesting that either the next two quarters will be somewhat poor or that the guidance will be greatly exceeded. In any case, for my estimates I will consider only 15% growth and 8% for the following years (the mid-to-high single digit growth of the guidance).
Since the arrival of the CEO, SG&A expenses have decreased drastically, not only has gross profit increased. In my estimate these will remain around $14M annually, therefore they will not decrease in absolute terms but in percentage terms with respect to revenue. Furthermore, I will estimate that R&D will remain around 2% of revenue as in the last 10 years.
This is what my estimates of sales growth and expenses to reach EBITDA would look like. Instead of reaching 25% gross margin in 2026, I will postpone it until 2028 to be cautious with management's projections, although in the past they proven to be capable.
Once I estimated EBITDA, I'll apply a multiple of 15 times since according to Seeking Alpha the sector average is around 16 times. Then, from the market cap I subtract the $2.5M in net debt and divide it among the 31M outstanding shares to arrive at a target share price of almost $9 USD in five years, this being more than 125% return without being aggressive in my assumptions.
I wouldn't pay much attention to the price target of previous years (2024, 2025, etc.) because it makes no sense to value it for an EBITDA that isn't yet fully developed. In these years it might be worth valuing it by EV/Sales, for example, for which the current ratio is 1.3 times while the sector average is almost 4 times.
I think that the company has a great risk as far as the quality of the product is concerned, because it has vital relevance for patients and if it doesn't fulfill its function confidence in Rockwell concentrates could be seriously lost. Likewise, if they maintain their reputation, I find it difficult for patients and health providers to risk experimenting with other concentrates, no matter how cheap they may be.
Another risk is that DaVita, a leading provider of kidney care, represented 47% of revenue during FY2023 and 46% during FY2022. I don't think DaVita would be interested in producing its own concentrates because I don't think a company with $12 billion in revenue would find it interesting to steal the $100M in revenue that Rockwell generates per year. On the other hand, what could be a big risk is if DaVita decided to buy from another concentrate supplier, but as I mentioned before, as long as Rockwell does well I don't think DaVita would want to experiment with other concentrate suppliers and risk them being lower quality. As it's often said colloquially "what doesn't fail can't be fixed".
It's also worth considering share dilution. Since 2020, shares have gone from 6.9M to 31M, increasing 47% on average ANNUALLY.
I think the company's mission is quite noble and it feels good to be part of a project like this that improves the lives of people who are having a hard time. Furthermore, being a small company, having a clever CEO is essential for the success of the investment which I consider that Rockwell does have.
Also, the valuation seems more than appealing right now, so I think it's currently a buy in which the shares could more than double in the next five years (with the associated risks).