Elevator Pitch
My rating for Masimo Corporation (NASDAQ:MASI) shares remains a Hold.
In my January 3, 2023, initiation article for MASI, I shared my view that Masimo has a “long growth runway,” but I noted that positives for Masimo have already been factored into its valuations and stock price. While MASI’s stock price has gone up by +11.8% (source: Seeking Alpha price data) since my initiation article was published, Masimo’s share price performance in the last five months is roughly in line with that of the broader market (+12.0% rise for the S&P 500).
After reviewing Masimo’s unchanged FY 2023 guidance and recent news flow relating to the company’s lawsuits and an activist investor’s moves, I don’t expect much upside for MASI’s shares in the short term. This explains why I have decided to retain my Neutral or Hold rating for Masimo.
MASI Kept Full-Year Guidance Unchanged Despite Q1 Earnings Beat
The mid-point of Masimo’s current full-year management guidance points to the company’s revenue and normalized EPS growing by +19.7% and +3.5% to $2,437.5 million and $4.75, respectively, for FY 2023. MASI stuck to its earlier FY 2023 financial guidance issued in late-February when it announced its Q1 2023 results in May. Masimo’s actual first quarter top line and bottom line beat the Wall Street analysts’ expectations by +1.3% and +4.3%, respectively; but MASI’s above-expectations Q1 2023 financial performance didn’t prompt the company to raise its forward-looking guidance.
In my view, there are good reasons for Masimo to take a prudent view of the company’s expected performance for 2023.
Firstly, FY 2022, or more specifically the 9M 2022 period, will be a tough base for comparison. MASI’s top line surged by +64.3% in the previous year. While Masimo’s revenue increased slightly by +1.7% YoY in Q1 2022, the company’s YoY sales growth rates for Q2 2022, Q3 2022 and Q4 2022, were +85.3%, +78.7%, and +88.4%, respectively. Masimo highlighted at its Q1 2023 earnings briefing that its top line had benefited from “fulfillment of backorders” resulting from “supply chain disruption” especially in the second quarter of the prior year. Therefore, it will be very difficult for Masimo to achieve strong top line expansion in FY 2023, considering the high base for last year.
Secondly, there is a high probability of Masimo’s actual FY 2023 profitability being weaker than expected, due to an unfavorable revenue mix, marketing costs relating to new product introductions, and legal costs. MASI has plans to launch new consumer healthcare products, which are expected to boast lower initial margins than existing legacy product offerings, in the quarters ahead. Also, Masimo had guided for an “incremental 100 basis points of promotional investments” for FY 2023 relating to new products at its first quarter earnings call, and this will inevitably hurt its profitability. In addition, MASI revealed that it has 5 ongoing legal cases with Apple Inc. (AAPL), which implies that the company is likely to incur meaningful legal expenses in the current year.
In a nutshell, there is a low probability of MASI’s actual FY 2023 financial results beating market expectations based on the factors mentioned above.
Masimo’s Valuations Are Unlikely To Rerate Following Unfavorable Developments
The market values MASI at a 32.7 times consensus forward next twelve months’ normalized P/E now as per S&P Capital IQ data. In comparison, the company has guided for a reasonably modest high single-digit to low-teens EPS CAGR for the long run at its Investor Day last year.
In fact, Masimo’s valuations remain elevated on expectations that its legal cases with Apple will be successful and that activist investor Politan Capital will bring about positive changes to the company. But recent developments suggest that the market might have been overly optimistic.
A May 1, 2023 Seeking Alpha News article mentioned that “a judge declared a mistrial in (Masimo’s) trade secrets trial against Apple” relating to “a blood-oxygen monitoring sensor used in its Apple Watch.” As per Seeking Alpha News’ May 1 report, “six of the seven jury members planned to vote in favor of Apple” in that trial, which offers negative read-throughs for any retrial.
Separately, it seems that it might be challenging for activist investor Politan Capital to work closely with MASI’s management on new initiatives to enhance shareholder value. On May 30, 2023, Politan Capital published a press release highlighting its director nominees for MASI, Michelle Brennan (former Johnson & Johnson (JNJ) executive) and Quentin Koffey (Politan Capital’s Managing Partner). While Masimo has supported the appointment of Michelle Brennan as a board member, the company has objected to the nomination of Politan Capital’s Quentin Koffey as a director. As such, it is reasonable to assume that it won’t be easy for Masimo to consider or accept suggestions from activist investor Politan Capital.
Given the uncertainty over future Apple legal case wins and potential collaborations with activist investment firm Politan Capital going forward, there has to be a valuation discount assigned to Masimo’s shares.
Concluding Thoughts
I am sticking to a Hold investment rating for Masimo Corporation. MASI’s unchanged guidance implies that earnings beats for the company in subsequent quarters of this year are less probable. Separately, one will have to be very optimistic to expect positive outcomes from Masimo’s legal cases against Apple and Politan Capital’s involvement with the company, taking into consideration recent developments. In that respect, I still think that a Hold rating for Masimo Corporation stock is the most appropriate.
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