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Morningstar | Insulet Poised for Further Growth and Profitability; Raising Our FVE

Insulet wrapped up 2018 in strong fashion, crossing over to profitability as we’d expected.  We’ve raised our fair value to $78 per share, with roughly half the increase driven by more optimistic long-term growth projections and half from cash flow realized since our last update. We remain confident in Insulet’s positive moat trend, as the firm seeks to penetrate the pharmacy distribution channel (in addition to its presence in the current durable medical equipment channel), enters full commercial launch of its OmniPod DASH system that offers mobile access to personal blood glucose data via smart phone, and continues to make progress on the development of its next-gen OmniPod Horizon. The firm’s strategy is solid and execution has been flawless. We think management’s plan for increasing access, and enhancing innovation and product differentiation are all strengthening Insulet’s competitive advantage.

Insulet exited the year with 22% topline growth, and ended in the black for the first time. The firm’s results since 2016 (following major management changes in 2015) support our expectations for mid-to-high teen topline and 60% bottomline growth (albeit off a very small base) through 2028.  While this year is likely to be focused on further investments, such that Insulet can support further innovation and increase capacity, we anticipate the firm can ramp up operating margin to 25% in 2027, up from 5% last year. We’re pleased to see Insulet’s aggressive posture, as it aims to chip away at Medtronic’s leadership position in traditional, tubed insulin pumps. Medtronic hasn’t been a slouch either when it comes to pump innovation, and we expect to see it’s next-gen hybrid closed loop pump in fiscal 2020.  Insulet has done a credible job of keeping the competitive gap narrow, and we think the anticipated rollout of its own hybrid closed loop pump next year should keep Insulet hot on the heels of the much-larger Medtronic.

We’ve been pleased to see the management team, under new CEO Shacey Petrovic’s leadership, has been able to make improvements on so many fronts—from manufacturing to development of the pipeline to reimbursement. By investing in a new automated U.S. manufacturing facility and opening a second line, we anticipate the firm will be able to exert more control over quality, reduce scrap, and increase gross margin (compared with its current facility in China). This decision to set up manufacturing in the U.S. goes beyond the matter of growing profitability. Having more control over quality also contributes to the firm’s competitive advantage. The complexity and multiple moving parts that go into a patch pump also mean there are more points at which something can go wrong. This complexity has operated as a barrier to entry. Considering the cost of manufacturing these patch pumps, if the level of defective units increases slightly, it can have a large impact on gross margin. We saw that happen at Insulet in the 2010 to 2013 time frame, under the previous management team, when the firm was unable to significantly reduce defects in its China manufacturing facility. Since then, Insulet has improved gross margin by 2000 basis points thanks in part to tighter quality oversight. Insulet’s expertise in manufacturing these complicated devices is formidable.