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Why the Somnomed Limited share price is cratering today

The Somnomed Limited (ASX: SOM) share price is down 5% to $3.28 today after the sleep treatment specialist revealed weaker-than-expected U.S. sales of its mouthguard-like medical device products for the quarter ending March 31 2017.

As a consequence the group has coughed up a triple whammy downgrade to product sales, total revenues, and full year EBITDA in a result the company blamed on the soft performance of its newly-created U.S. subsidiary Renew Sleep Solutions.

SomnoMed conceded the change in sales delivery channels that involved the creation of its new subsidiary has affected some practitioners’ buying patterns, with revenues for the quarter up just 2% over the prior corresponding quarter.

This is hardly the kind of growth expected from a richly-valued junior medical device business and the group’s forecast for a full year EBITDA loss of $1.5 million is also a big downgrade from prior guidance that it would “break-even” on an EBITDA basis.

Total cash outflow for the quarter was nearly $1.9 million, with $13.9 million in cash left on the balance sheet. The group suggested around $1.4 million of the cash outflow was related to start up expenditure for its new business in the US, although investors may start to get nervous over the prospect of a capital raising if it doesn’t improve cash flows soon.

Outlook

Given the company’s valuation and today’s significant downgrade to expectations I expect the shares could fall further over the weeks ahead, although SomnoMed does have some attractive qualities as a growing medical device company.

Overall, I would prefer to wait until I see evidence that the company can control its costs while growing sales before buying shares and given today’s downgrade think it looks a stock for the watch list.

A preferable bet in the junior medical device space may be hospital disinfectant equipment specialist Nanosonics Ltd (ASX: NAN). It’s also on a big valuation, but is growing sales at phenomenal rates and appears to have a genuinely market-leading product, while also posting healthy profits. Nanosonics shares are changing hands for $3.12 this afternoon and may be a better bet than SomnoMed.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of Nanosonics Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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