The Motley Fool

Is Admedus Ltd’s fourth-quarter update a bad sign for investors?

When it comes to investing, I have a ‘no biotech research stocks’ rule. It’s served me well and I’ve broken it only once – when I bought Admedus Ltd (ASX: AHZ).

At the time, I liked the fact that Admedus had successfully developed a product (a big deal among biotechs) and was experiencing growing sales worldwide. I also liked the potential to expand sideways into other uses for its ADAPT tissue products, addressing a wider range of surgical needs. While it wasn’t immediately material to my thesis, the vaccine developments humming away in the background were an additional plus.

After today’s release from Admedus, I find myself wondering whether my investment in the company was really a good idea. Before I elaborate, here’s what you need to know about today’s fourth-quarter update:

  • Full-year revenue rose 29% to $10.9m (including $1.1m tax rebate)
  • Operating cashflow of negative $21.5m
  • CardioCel now used in over 90 centres globally (USA, Europe, Canada, Singapore, Hong Kong) with ‘more than 70’ centres added in past 12 months
  • Expansion into wider range of ADAPT tissue uses
  • Continued vaccine development

The expansion of CardioCel is great news and key to the company’s growth as its products become more widely used. Presumably this also allows for working relationships to be established with various professional organisations, allowing future products from Admedus to be more easily pitched (since Admedus will have a track record).

However, I have massive concerns over Admedus’ cash flows. The company incurred expenses of $32 million in the past 12 months and a disturbingly high percentage of this was not spent on Research and Development (R&D) or marketing:

  • $12.9m on ‘staff costs’
  • $0.6m on ‘advertising and marketing’
  • $3.7m on ‘research and development’
  • $14.7m on ‘other working capital’

Admedus claims that the high costs are ‘a direct result of the Group’s focus on building the infrastructure, resourcing and sales capacity required to continue revenue growth for the next year and beyond.’

I assume that this is why most of the staff expenses were incurred. Readers will be comforted to know that the entire board including the Executive Director and Managing Director only cost $1.6m in the previous financial year, so unless they’ve received massive pay rises this year they don’t look to be a high portion of expenses.

Senior executives are paid a minimum of 84% of their salary in ‘base pay and benefits’, which I feel is too high and does not adequately align their interests with shareholders. However, a far bigger concern is the massive cash outlay for only a 29% increase in revenue. Even more concerning is that the staff expenditure is nearly 3 times as large as R&D and marketing combined.

Given the relative opaqueness of the company, investors are left with no choice but to trust that management is investing wisely on their behalf.

Admedus is growing and with expenditure on staff there could be a rapid increase in sales next year as management markets its product to more businesses. However, the thing about staffing costs is that they are relatively fixed and recur annually, meaning there will need to be a major lift in sales to compensate for higher costs.

I will be keeping Admedus on probation for 12 months while I wait to see if the company will deliver.

Discover two of my favourite small-caps...They're a better bet than Admedus!

Two of Australia’s most promising small companies are still flying under the radar - and I recently bought one of them at prices higher than today's offer! Discover these two exciting ASX investments in our brand-new special report, “2 Small Cap Superstars”.

Simply click on the link, enter your email address and we'll send you our full coverage for free - no credit card details or payment required.

What are you waiting for? Just click here now for your copy.

Motley Fool contributor Sean O'Neill owns shares of Admedus Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. 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.

FREE REPORT: Five Cheap and Good Stocks to Buy now…

Our Motley Fool experts have FREE report, detailing 5 dirt cheap shares that you can buy today.

One stock is an Australian internet darling with a rock solid reputation and an exciting new business line that promises years (or even decades) of growth… while trading at an ultra-low price…

Another is a diversified conglomerate trading near a 52-week low all while offering a 2.7% fully franked yield…

Plus 3 more cheap bets that could position you to profit over the next 12 months!

See for yourself now. Simply click the link below to scoop up your FREE copy and discover all 5 shares. But you will want to hurry – this free report is available for a brief time only.