Is Establishment Labs Holdings (ESTA) Too Good to Be True? A Comprehensive Analysis of a ...
Value-focused investors are always on the hunt for stocks that are priced below their intrinsic value. One such stock that merits attention is Establishment Labs Holdings Inc (NASDAQ:ESTA). The stock, which is currently priced at 45.39, recorded a loss of 7.5% in a day and a 3-month decrease of 33.84%. The stock's fair valuation is $82.95, as indicated by its GF Value.
Understanding the GF Value
The GF Value represents the current intrinsic value of a stock derived from our exclusive method. The GF Value Line on our summary page gives an overview of the fair value that the stock should be traded at. It is calculated based on three factors: historical multiples (PE Ratio, PS Ratio, PB Ratio and Price-to-Free-Cash-Flow) that the stock has traded at, GuruFocus adjustment factor based on the company's past returns and growth, and future estimates of the business performance. The GF Value Line is the fair value that the stock should be traded at. If the stock price is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher.
Assessing the Risks
However, investors need to consider a more in-depth analysis before making an investment decision. Despite its seemingly attractive valuation, certain risk factors associated with Establishment Labs Holdings should not be ignored. These risks are primarily reflected through its low Piotroski F-score and a Beneish M-Score of -1.59 that exceeds -1.78, the threshold for potential earnings manipulation. These indicators suggest that Establishment Labs Holdings, despite its apparent undervaluation, might be a potential value trap. This complexity underlines the importance of thorough due diligence in investment decision-making.
What is the Piotroski F-score / Altman Z-score / Beneish M-score?
Developed by Professor Messod Beneish, the Beneish M-Score is based on eight financial variables that reflect different aspects of a company's financial performance and position. These are Days Sales Outstanding (DSO), Gross Margin (GM), Total Long-term Assets Less Property, Plant and Equipment over Total Assets (TATA), change in Revenue (?REV), change in Depreciation and Amortization (?DA), change in Selling, General and Admin expenses (?SGA), change in Debt-to-Asset Ratio (?LVG), and Net Income Less Non-Operating Income and Cash Flow from Operations over Total Assets (?NOATA).
Company Introduction
Establishment Labs Holdings Inc is a medical technology company engaged in offering medical devices and aesthetic products. It is involved in designing, manufacturing, and marketing silicone-filled breast and body shaping implants. The company markets its products under Motiva implants Brand. It distributes its products to medical distributors; and physicians, hospitals, and clinics in the form of direct sales. Its geographical segments are Europe, Latin America, Asia-Pacific/Middle East, and Others.
Historical Data Analysis
The days sales outstanding (DSO) is an important financial metric that denotes the average time a company takes to collect payment after a sale is completed. Looking at the historical data from the past three years (2021: 0.73; 2022: 0.92; 2023: 0.81), there appears to be a recent surge following an initial decline in Establishment Labs Holdings's DSO.
An uptick in DSO might indicate aggressive revenue recognition practices, and in some cases, potential earnings manipulation. To explain, when DSO increases, it means the company's receivables are growing. This could be a result of sales being recorded before customers have paid, which inflates the revenue figures. In extreme cases, a company may even recognize revenue from sales that may never be collected, an action that is considered earnings manipulation. A rising DSO figure warrants scrutiny as it can signal financial distress or questionable accounting practices within the company. Therefore, investors should closely monitor such trends for early detection of any potential financial risks.
The Gross Margin index tracks the evolution of a company's gross profit as a proportion of its revenue. A downward trend could indicate issues such as overproduction or more generous credit terms, both of which are potential red flags for earnings manipulation. By examining the past three years of Establishment Labs Holdings's historical data (2021: 63.68; 2022: 66.84; 2023: 64.66), we find that its Gross Margin has contracted by 0.3%. Such a contraction in the gross margin can negatively impact the company's profitability as it signifies lesser income from each dollar of sales. This could put a strain on the company's capacity to manage operating costs, potentially undermining its financial stability.
Potential Earnings Manipulation
Next is the leverage index, which is computed as the change in the Debt-to-Asset Ratio. An increase in this ratio may suggest that the company is taking on more debt, thereby potentially inflating earnings.
The TATA (Total Accruals to Total Assets) ratio, calculated as the Net Income less Non-Operating Income and Cash Flow from Operations, divided by Total Assets, is a key indicator of the quality of a company's earnings. For Establishment Labs Holdings, the current TATA ratio (TTM) stands at 0.08. A positive TATA ratio can be a warning sign, suggesting that the earnings are composed more of accruals rather than cash flow, which could be an indication of aggressive income recognition. Accrual accounting permits management some discretion in recognizing revenue and expenses, and a company intent on artificially boosting its earnings might exploit this flexibility.
In essence, a higher TATA ratio might mean that the company's reported income is not as firmly grounded in real cash earnings, signaling poor quality of earnings, potentially resulting from accounting gimmicks or financial engineering rather than true operational performance. Investors and analysts should examine the components of the TATA ratio closely, especially when the value is positive, to understand the underlying drivers and assess whether it might indicate a need for more detailed scrutiny of the company's financial practices.
Conclusion
In conclusion, while Establishment Labs Holdings Inc (NASDAQ:ESTA) appears to be undervalued based on its GF Value, the company's financial metrics and potential risks suggest that it could be a value trap. Investors should exercise caution and conduct thorough due diligence before making an investment decision. To find out the high quality companies that may deliver above average returns, please check out GuruFocus High Quality Low Capex Screener.
This article first appeared on GuruFocus.
