DexCom’s (NASDAQ: DXCM) success can be attributed to the rapid adoption by the diabetic community of its innovative continuous glucose monitoring (“CGM”) system.

This disposable device worn on the body continuously downloads the patient’s blood sugar to a smartphone and therefore provides patients with a convenient way to track their blood sugar levels in real time, which helps in better managing the disease.

DexCom’s share price has been on a steep uptrend and currently trades at two times March lows. Moreover, there has been a recent dip to the $385-390 levels, leaving investors wondering as to whether this constitutes a buying opportunity.

Figure 1: Share price evolution

ChartData by YCharts

I will answer this question by scanning through the CGM market as well as analyzing the medical device manufacturer’s business model, highlighting the positives but also paying close attention to competitive positioning and challenges going forward.

The market for diabetes

According to an analysis of the U.S. diabetes market done in August and covering the 2020-2025 period, there is a rise in the number of diabetic patients who are using self-monitoring blood glucose devices.

The forecast is for the diabetes monitoring market to reach $26.28 billion by the year 2025.

Moreover, by discouraging people to attend diagnostic labs for routine tests because of infection-related fears, the coronavirus pandemic outbreak has accelerated wider adoption of medical devices such as DexCom’s lab-at-home glucose meters.

Figure 2: DexCom G6 CGM

Source: DexCom.com

Now, revenues, while having been impacted by COVID-19 in the first quarter of 2010 compared to the peak observed in Q4 2019, have recovered to a large extent. For that matter, sales for Q1 2020 and Q2 2020 are up compared to the same quarters last year by over 40% and 30%, respectively.

Figure 3: Quarterly income statement

Source: Seeking Alpha

Looking further into the income statement, the second quarter’s gross margin of 63% was higher compared to the 61% obtained in the second quarter of 2019 due to an improvement of product design, resulting in a transmitter with lower cost of manufacturing.

Furthermore, had it not been for some costs incurred in association with the introduction of the newer G7 (upgrade of the G6 glucose monitor), gross margins would have been higher.

Going forward in the second half, the company expects a moderation in margins. In the words of Quentin Blackford, CEO, speaking during the Q2 2020 earnings call:

“Just as COVID did impact our topline, it also had an impact on certain spending activities, which resulted in some of the operating margin improvement during the quarter and was therefore, temporary in nature.

As a result, we expect moderation in the year-over-year margin comparisons in the second half of the year as we invest in several key initiatives for the company, including the G7 clinical trials, G7 manufacturing scale up, our new market efforts and direct-to-consumer advertising that we began to accelerate late in the second quarter.”

Therefore, G7 devices should start to positively impact sales only as from 2021. In the meanwhile, DexCom already sells the profitable G6 CGMs but also encounters competition.

The competition

Despite being an emerging technology, there are other big names like Abbott Labs (ABT) and Medtronic (MDT) already providing CGM diagnostic kits as well as lesser known ones like Eversense (NYSEMKT:SENS).

Figure 4: Features of the technologies

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Source: eunethta.eu

The table, which dates back to 2018, provides a technical comparison of product features, and the key coveted feature by device manufacturers is the “non-adjunctive” label which is approved by the FDA. This label, which was initially only awarded to DexCom and ABT, was only granted to Eversense in 2019 while Medtronic only recently requested approval.

This technical comparison reveals that DexCom has some level of product differentiation with that non-adjunctive label, but most importantly, that through the three models proposed, it provided patients with more choice. The development of the CGM G7 should perpetuate this strength.

I continue with a financial comparison with the aim of analyzing the company’s double-digit sales growth figures in context of the wider industry.

For this purpose, I already covered ABT and Medtronic during my recent thesis on the Health Care Select Sect SPDR ETF (XLV).

Figure 5: Comparison with peers

Source: Seeking Alpha

Remarkably, DexCom’s revenue growth of 40% shines when compared to the meager single-digit or negative values for peers and this in light of the coronavirus pandemic.

Therefore, it is important to understand the reason for these phenomenal growth figures is more synonymous with software companies delivering applications over the internet and having subscription (regular) fees.

The answer lies in the business model.

The business model, outlook including challenges

First, every consumer who signs up is locked up in buying high-margin consumables for years to come. With more and more patients enrolled every day, DexCom’s revenue growth has been surging.

In this context, some will have noted that the sensor (figure 4) is a consumable item that expires after ten days. This signifies that it has to be replaced with a box costing $349.

Second, the company specializes in glucose level monitoring and works with the likes of Tandem (NASDAQ: TNDM) for the control of diabetes through the release of insulin in the blood. Thus, DexCom’s G6 CGM, used together with Tandem’s Diabetes Care T:slim X2 pump, automatically delivers insulin based on blood sugar readings without the need for fingerstick draws (removal of a blood sample for testing) or daily injections.

Third, the company uses eCommerce to generate sales. In this respect, nearly 70% of all of patients come across DexCom’s products for the first time through “some sort of either virtual training or online training capability or in-app capability” as per the management.

Interestingly, the two countries where the company has strong eCommerce platforms, namely Canada and the UK, were its highest growth markets in the second quarter.

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On the other hand, there are also challenges going forward.

In addition to the challenges posed by the second and third waves of COVID-19, development of alternative technologies by rivals can result in loss of market share for DexCom.

Moreover, another challenge could be constituted by Medtronic with its SmartGuard technology, inbuilt into the MiniMed 640G Insulin Pump which proactively minimizes the occurrence of hypoglycemia through automatically adjusting insulin rate.

The advantage of the insulin pump is that it provides an integrated solution for the client instead of, for example, having to purchase a glucose monitor from DexCom and insulin pump from Tandem separately.

This possible threat to loss of market share seems to have been addressed through product bundling with Tandem, whereby integrated proposals are made to customers.

Also, thinking aloud, the fact that DexCom is winning over new patients, especially through direct sales, at the rate of 75% to 80% in the second quarter does not indicate loss of market share.

Moreover, some new patients were restrained to effect clinical trials due to social distancing measures but some recovery was seen in June and July. In addition, product orders were gained through distributors (indirect sales) during that time and there is cautious confidence that this will continue.

Looking from the strategic perspective, the fact that DexCom has made a name for itself in the fight against diabetes by eliminating the need for fingersticks is a strong positive to tap in the enormous diabetes market (34.2 million Americans and millions throughout the world).

Figure 6: DexCom growth opportunities in the US market

Source: investors.DexCom.com

The company had 200,000 active patients in 2017.

In this respect, the medical device play is gaining steady traction for new patients in the type 2 market as insurance coverage expands.

Therefore, DexCom has the ingredients to further continue its double-digit growth in the third quarter.

However, the executives are prudent and do not want to display short-term optimism for the third quarter.

Given DexCom’s high Debt to Equity ratio of 130, I check whether this prudent attitude also included appropriate actions to service existing debt.

In this case, in May, the company took advantage of market conditions to solidify its balance sheet through the issue of a new convertible note offering.

Hence, including the proceeds from the offering, there was $2.5 billion of cash at the end of the second quarter sufficient to pursue the growth opportunities, including expansion in new markets.

I further verified the company’s quarterly SEC filings and found that the company had a total debt of $1.76 billion with $850 million of senior convertible notes due in 2023.

However, the debt level has increased by 58% within the period of three months.

Figure 7: DexCom total long-term debt progression

ChartData by YCharts

Therefore, DexCom has an elaborate business model based on high growth, including consumables in addition to devices, strategic partnerships, differentiated sales channel.

Debt is also at a high level, but considering that the company has the capacity to pay back its dues, I do not view this as a concern as long as the company continues to deliver high growth.

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Valuations and Key takeaways

First, with a revenue growth of twenty times Abbott’s 1.65%, DexCom deserves its trailing P/E (GAAP) of 3 times ABT’s at 182. Also, DexCom has higher profitability.

Figure 8: Comparison with peers

Source: Seeking Alpha

Also, I have also included Abiomed (ABMD) in the comparison table which is a manufacturer of artificial heart pumps. The company does not compete with DexCom, but similarly to the latter, continuously brings improvement in design leading to reduced costs of production and higher profitability. Its gross margins stands at 81%.

My forecast is for DexCom to reach those profitability levels with its CGM G7 product line in 2021.

However, since the medical manufacturer forms part of the NASDAQ, it is also subject to volatility because of the current rotation from tech to value stocks. Also, due to current market conditions, the way the debt item is addressed during the third quarter must be monitored.

Hence, I have a cautious longer-term target price of $450-460 by June of 2021.

Also, for those who want to have the stock in their portfolio but are not prepared to pay the $385+ amount, there are a number of ETFs holding DexCom with the most important one being the Vanguard Total Stock Market ETF (VTI).

Figure 7: ETFs holding DexCom

Source: etfchannel.com

To support my bullish stance, investors will note that the company has reinstated full-year guidance.

Hence, total revenue for 2020 should be around $1.85 billion, representing growth of 25% over 2019. This represents an increase of $100 million from the initial guidance.

This said, third-quarter profitability will be on the lower side due to additional costs incurred with the development of the G7 product line.

Still, the current environment where diabetes sufferers are more prone to suffer complications from COVID-19 favors DexCom’s products, and the virtual patient care tool developed by the company is an important differentiator.

Finally, the need to appropriately monitor diabetes being key to prevent other serious health complications such as kidney and heart diseases, I see continuous coverage by medical insurance going forward.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long XLV.
This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.



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