Does This “Nuclear” Stock Pass Our Stress Test?

Anytime you need a nuclear physicist to help create a new technology, you know you’re dealing with something truly extraordinary.

That’s exactly the case in the field of radiopharmaceuticals.

Simply put, radiopharmaceuticals are drugs that contain radioactive properties.

No, they’re not going to melt your face off.

These drugs are critical in diagnosing and treating many common illnesses, including cancer.

And as the Mayo Clinic says, “Radiopharmaceuticals are to be given only by, or under direct supervision of, a doctor with specialized training in nuclear medicine.”

Serious business, indeed.

Today, I’m going to profile a leader in this highly specialized field. Its nuclear medicine technology is undoubtedly helping to save lives.

The question is: How does it stack up as an investment?

~Cash

Founded in 1985, Digirad (DRAD) designs diagnostic imaging equipment for use in nuclear medicine.

It’s a pioneer in the field, having been the first company to design “solid state” technology of this kind for use in cardiology, vascular imaging, neuropathy, pediatrics, and ultrasound.

As always, we dive into the company’s cash and financials first. And off the bat, Digirad boasts a healthy $19.4 million in cash, with zero debt.

Fueled by a 12.6% revenue growth rate in the last quarter, the company’s sales growth is pretty healthy, too, outpacing its industry average by 3.5%.

In fact, on its last earnings call, Digirad announced a surprise $0.01 in earnings per share, which was $0.02 higher than analysts expected.

However, despite its recent quarter being positive, Digirad’s history is far more erratic.

Aside from the occasional quarter-over-quarter revenue boosts, Digirad’s overall revenue has declined consistently for years.

Its gross profit is mostly down (and significantly) from previous years, too. And net income has only been positive in three of the last 10 years.

The reason for such upheaval?

Well, over the past decade, Digirad has undergone some significant hardships. The most notable came in 2010, when the firm endured a massive shortage in the international radiopharmaceutical supply chain.

Revenue dropped by 23%, and gross profit tanked by 68%.

So can Digirad turn things around? The jury is out…

While there have been glimmers of hope, the 2010 disaster has had a long-term impact.

I feel Digirad’s management should have shown greater foresight in anticipating – and preparing for – the radiopharmaceuticals shortage. It caused major damage, and I’m concerned that they won’t be able to handle any repeat performance in the future.

C.H.A.O.S. Meter: 9/20

~High Impact

Cardiac disease runs rampant in America. In fact, it’s the No. 2 killer.

But Digirad wants to stop this trend through its nuclear cardiology camera technology.

You see, once a patient takes a radiopharmaceutical drug, it zeroes in on the affected area and puts out radiation. As a result, the body emits gamma rays, which are picked up by an imaging camera.

Not just any old camera, mind you. It must be a special gamma ray camera, which allows doctors to see where the cancer is and how the organ is working.

These gamma ray cameras didn’t even exist until Digirad created and introduced them to the medical device industry back in 2000.

Talk about hitting a market with high impact!

But that was 14 years ago. Today, with powerhouse rivals like General Electric (GE) and Siemens (SIEGY) making similar technology, Digirad faces an entirely new competitive landscape.

Technologically speaking, though, the company is a pioneer – and it’s staying true to those roots by innovating in new ways.

For example, by converting its gamma ray cameras into solid-state gamma ray cameras, Digirad is now mobilizing nuclear medicine.

In other words, it’s literally moved nuclear medicine from the hospital into doctors’ private offices. How? Simple economics…

As manufacturing volume increased and the cost of production declined, it allowed Digirad to invest more R&D into making its cameras smaller and more portable. That later evolved into making a “two-headed camera,” and then a camera with three detector heads – which is now the fastest scanning camera in the industry.

This 3-D imaging allows doctors to see a patient’s heart from all sides and angles.

Depending on the number of scanners, an imaging session can take anywhere from seven minutes to 45 minutes. But with software that Digirad is developing today, it’s aiming to shrink that time to three minutes.

C.H.A.O.S. Meter: 19/20

~Acceleration

Digirad is a turnaround story, so its biggest acceleration will come from an uptick in earnings.

Coming off its best year, analysts have set a fairly high bar in terms of earnings estimates.

But by several important metrics – such as enterprise value, return on assets, and return on equity – Digirad is trading at or around its five-year maximum…

Is Digirad Maxed Out?

Click here to enlarge

Digirad’s second-quarter results are due on July 30, with the $0.03-per-share earnings estimate more than attainable. That could prove to be a nice near-term catalyst.

However, I don’t think Digirad will meet its expectations in the third quarter. And beyond that, Digirad’s long-term acceleration is running out of gas.

C.H.A.O.S. Meter: 10/20

~Orders

Digirad’s sales come from two areas…

Diagnostic Imaging: This segment includes the sale of solid-state gamma ray cameras (along with maintenance contracts) and ultrasound equipment. For fiscal 2013, this revenue stream decreased by $2.2 million – down 15.5% compared to 2012. However, in Q1 2014, revenue rose by 32%, due to a higher average price for its cameras.

Digirad Imaging Solutions: This revenue stream provides in-office services to physicians who need to perform nuclear cardiology imaging, echocardiography, vascular, or ultrasound tests. The segment accounts for 73.5% of Digirad’s total revenue – and has risen steadily in recent years. In 2013, sales were up 3.1% over 2012. And first-quarter revenue rose by 6.8%, versus Q1 2012.

Overall, Digirad’s orders can prove unpredictable, largely due to changes in healthcare budgets and regulation.

In addition, the supply problem for radiopharmaceuticals since 2010 has added another obstacle, forcing the company to cancel services that it was set to provide.

C.H.A.O.S. Meter: 13/20

~Scalability

When most companies scale their business, they usually do it by branching into different sectors or sub-sectors.

However, Digirad’s business is firmly fixed on the medical field – and a niche area, at that.

This isn’t a bad thing, as there are 13 million people per year who rely on nuclear cardiology.

But it means Digirad can’t really hit growing trends outside its industry.

As a leader in its field, though, the company can scale its business by tapping into growing trends like on-demand services and concierge medical treatment.

In terms of its technology, Digirad is focusing on Single Photon Emission Computed Tomography (SPECT). This technique uses gamma rays and cameras to give even clearer 3-D images, allowing doctors to see cross-sections of a patient’s affected area and manipulate the images as needed. It’s a technique in high demand at larger hospitals and clinics.

In the coming years, SPECT procedures are expected to be used in most imaging procedures. This will give patients easier access to nuclear medicine – and bring more patients to Digirad’s services, as a result.

As with the Orders section, the biggest drag on Digirad’s growth is Washington. As both physicians and customers continue to experience insurance and reimbursement uncertainty, it’s hit Digirad’s business.

So, even as Digirad tries to boost its technology, legislative roadblocks are squeezing its revenue growth.

C.H.A.O.S. Meter: 12/20

ChaosMeterOVERALL C.H.A.O.S. RANKING: 63/100

 

Final Verdict: Although Digirad has some pretty “rad” technology, it continues to skate under the radar. And that’s after it revolutionized the medical imaging industry.

In short, the company’s chance to create real chaos has passed. In addition to its shaky financials, limited scaling opportunities and Washington regulations make this a no-go in the long term.

As a score of 63 suggests, this isn’t a total failure… but given my concerns, the best chance to profit lies only in a speculative short-term trade. As I mentioned, Digirad reports earnings on July 30, so consider a quick play on a positive report, then “sell the news.”

Your eyes in the Pipeline,

Marty Biancuzzo

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Anytime you need a nuclear physicist to help create a new technology, you know you’re dealing with something truly extraordinary. That’s exactly the case in the field of radiopharmaceuticals. Simply put, radiopharmaceuticals are drugs that contain radioactive properties. No, they’re not going to melt your face off. These drugs are critical in diagnosing and treating...

Marty Biancuzzo

, Technology Analyst

View More By Marty Biancuzzo