Accuray (NASDAQ:ARAY) is certainly in the running for being one of the most frustrating stocks I’ve followed. While the company has made a lot of smart moves to improve its product portfolio and boost its growth prospects, market share has been frustratingly slow to follow and the stock has languished for years as the company hasn’t been able to really close much of the gap with Varian (owned by Siemens Healthineers (OTCPK:SMMNY)) or Elekta (OTCPK:EKTAY). Since my last update, despite two relatively decent quarters, the shares are down another 20% without any obvious negative catalysts.
Set against this is the possibility that revenue could ramp significantly in a short time. Management has a solid track record with revenue guidance and if their projections are accurate, revenue should accelerate about 7% sequentially next quarter and over 20% the quarter after that, leading to an 18% year-over-year comp in FQ4’24 that should draw some positive attention.
The story here remains much the same as it has – the central question being whether the company can replicate the significant (market-leading) market share it holds in China’s Type A market with its entry into the more value-priced Type B market (worth approximately $600M) and establish a new, higher, bar for revenue growth and expanded margins. Early signs are positive, and the shares aren’t expensive, but this is a consummate “show me” stock after years of false starts and a frustrating lack of progress.
Will Execution In China Lead At Last To Meaningful Growth?
I’ve talked about this before in various notes on Accuray, but the company has actually done a lot to improve itself over the past decade. From product reliability to treatment times to value-added planning software, the company has fixed virtually all of the issues that used to be cited as significant roadblocks to wider adoption of the company’s systems. At the same time, there has been ongoing growth in awareness of the value of hypofractionation and ultra-hypofractionation (treating cancer with higher doses of radiation over fewer sessions).
And yet … Accuray’s market share really hasn’t budged and revenue growth over the trailing decade is a stagnant 2% or so. While quarter-to-quarter comparisons aren’t always fair and there is imperfect overlap comparing Accuray, Elekta, and Siemens Healthineers (they have different reporting schedules), Accuray still only has around 7% to 8% of the market … much as it has for the past decade and the company has struggled to score competitive takeaways in important markets like the United States.
China is supposed to be different. Despite its small size, Accuray has been quite successful in winning share in China’s Type A market (taking over 80% of available licenses in many years), and now the company is targeting the much larger Type B market. While the Type B market puts a much greater premium on value/pricing, Accuray’s partnership with China Isotope & Radiation (or CIRC) gives the company a strong local manufacturing, distribution, and service capability that should make it a very competitive player in this $600M annual market.
Orders are starting to roll in for the Chinese Tomo C system, helping drive 18% year-over-year gross order growth, including 44% growth in China. As these systems start delivering in the fiscal four quarter of this year, the impact to the income statement should be meaningful, putting worthwhile revenue growth back on the table as a driver for the shares.
Just 20% share of China’s Type B market would have a transformative effect on a company with annualized revenue around $425M, and the opportunity isn’t limited to China. Accuray has taken the same basic Tomo C concept and launched its value-priced Helix platform in India, and while not likely to be as large of a market for Accuray in the near term, India is certainly large enough to matter to Accuray (to say nothing of other potential developing markets).
Execution Remains Vital
Even with the boost that Chian can potentially provide to Accuray, the company can’t rest on its laurels. Varian is an exceptional operator in radiation oncology and has been for decades; they are the incumbent in most markets that matter and they’re difficult to beat on product performance or service, particularly now as part of Siemens Healthineers where products can be developed in conjunction with imaging systems.
Elekta is a more “gettable” rival, but hardly a sitting duck. Elekta has struggled of late, with orders down 17% year over year (including a 50% drop in China) and gross margins down about 10 points over the past decade, but Elekta is still more than 4x Accuray’s size in terms of orders and revenue and spends twice as much on R&D and three times as much on sales and marketing.
With this, Accuray needs to be smart and pick its battles. Accuray has done well in Japan and this remains a high-priority market (and one where Elekta has less traction). In more competitive markets like the U.S., Accuray is trying to focus on upgrading and refreshing its installed base and competing for selective vault share gain opportunities, particularly in cases where there’s more interest in the hypofractionation capabilities of Accuray’s system and newer offerings like adaptive planning capabilities.
Greater acceptance of hypofraction could yet become a tailwind for Accuray, but it’s taking a long time to develop in the United States. Numerous studies have shown that various types of cancer (including brain, breast, and prostate) can be treated just as effectively with a hypofractionated approach and with improved patient quality of life and lower costs. While payors and physicians are generally on board, institutions are dragging their feet as hypofractionation means taking a hit to what can be a lucrative “assembly line” business in their radiation oncology department. A new reimbursement proposal that mitigates some of the impact on hospitals could help accelerate adoption, but it likely won’t come into play for at least another year.
I’d also note again that the company has a partnership with GE HealthCare (GEHC). It’s hard to say that this agreement has made a major contribution to the business so far, but it hasn’t hurt it either and management has spoken of the GE relationship leading to an improved reception from potential hospital customers (GE can make the intro’s into hospitals where Accuray has no existing presence, making it somewhat of a less missionary sales effort).
The Outlook
Everything seems on track for a significant ramp to close this fiscal year; projected fiscal third quarter revenue will likely be down modestly year over year, before accelerating significantly in the fourth quarter. Then comes the question of follow-through – can the Type B business in China accelerate further throughout 2025 and can the company generate better results in Japan and the U.S. such that more meaningful revenue growth becomes viable?
Right now I’m above the Street and at the high end of management’s guidance for FY’24 and I’m likewise a bit above the high end of the published Street range for FY’25 revenue. I hope I’m actually conservative and high single-digit (or better) revenue growth comes into play. If not, it’ll be hard to find a reason to remain bullish, as slow-growth small-cap med-tech is just not a place where success is easy to find.
Modeling mid-single-digit long-term revenue growth and FCF margins that gradually move toward 10% is enough to support a $4 fair value on a discounted cash flow basis, and a 10% or better EBITDA margin in FY’25+ can likewise support a fair value of $6 or more.
The Bottom Line
Given the long history of false starts and dashed expectations, I understand why the Street isn’t in a rush to pile into these shares. The U.S. market is looking a little lackluster now, with Accuray and Elektra management both sounding fairly cautious on the near-term prospects, and it remains to be seen how quickly China can become a true driver for the company (and how long the momentum will last). The pieces are in place for this to become a much more exciting stock in the second half of this year, but this is still really only a stock suitable for risk-tolerant investors.
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