Semler Scientific Stock: Why I Buy (NASDAQ: SMLR)

Shares of Semler Scientific (SMLR) have been completely destroyed since the release of Q4-21 results on February 28. amid the market downturn in recent months.

I view this as a great buying opportunity and am adding to my position. I initially invested in 2020 with a cost base in the $70s. In the five quarters since I invested, the company has delivered strong operating results and recovered from business issues caused by Covid-19. Semler has long-term growth potential and is likely to provide excellent returns against the recent $40 high price range.

Q4-21: Variable costs

Prior to Covid-19 in 2020, Semler was a small-cap revenue growth darling, posting growth rates of over 50%, including in 2019 when the company grew revenue by 53%.

Source: company press releases, 10-K, authors tables

However, the company has experienced growing pains in the first half of 2020 due to the nature of its business. Semler is largely a one-product company. It licenses software with its medical device called QuantaFlo, which is a finger cuff used by a provider who rapidly tests a patient to Peripheral arterial disease (aka PAD).

Semler licenses QuantaFlo to health insurers, physician groups and health risk assessment companies. Customers have one of two purchasing models: fixed (recurring) fee or variable fee. Fixed costs have traditionally provided the bulk of business revenue, but variable costs are still important. In 2021, variable costs represented 41% of revenue from Semler’s vascular tests.

When Covid hit in 2020, variable fee revenue – which is based on testing volume – was hammered. Routine medical visits and elective medical care have been suspended as the health sector has prioritized essential medical services. This hurt Semler. Below is an overview of Semler’s second quarter revenue between 2019 and 2021, which illustrates how Covid has severely impacted variable fee revenue in 2020:

Source: company press releases and authors’ tables

Variable costs were hit in the first half of 2020 and started to recover in the second half. The opposite happened in 2021: variable costs increased in the first half of 2021 and slowed down in the second half. In Q4-21, variable commission revenue decreased 22% year-over-year and overall revenue was down 5%.

Look forward

The company does not issue guidance and executives on the fourth quarter earnings call said they were unsure if the new variable expense trend (strong first half of the year / weak second half) will remain a permanent feature in the future.

Selling after earnings results was severe. Revenue and EPS fell short of analyst consensus estimates. Semler is small cap and fair three analysts officially cover the company.

For fiscal 2021, revenue growth was strong at 37%. The company generated free cash flow of $15 million and has recorded strong free cash flow generation in recent years. The company is in excellent financial condition and is based on $37 million in cash.

Semler has a lot of positives for his company. Its QuantaFlo patent does not expire before 2027. The company’s main technology competitor is the traditional blood pressure cuff ABI device. PAD often goes undiagnosed because it is largely asymptomatic. Recent results from a peer-reviewed study in Nevada showed the benefits of preventing future death and disease by detecting PAD using QuantaFlo. And the primary market for the use of QuantaFlo is the Medicare population, which will continue to to augment in size to a solid clip.

Additionally, Semler is in the early stages of introducing two new software offers focused on diabetes and Alzheimer’s disease in partnership with smaller companies that created the technology. These new initiatives are not material to the company at present, but the company is making efforts to diversify its business.

Valuation / Conclusion

Semler increased EPS by 22% in 2021. Assuming the company increases EPS by 20% in 2022, we have Semler trading at a forward P/E of 19 at $47.20/share. This includes $37 million in cash on the books at a market cap of just under $320 million. For comparison, the Russell 2000 index trades at a premium to Semler with a Front P/E of 22. Given Semler’s growth profile, market opportunities and strong financial position, I wouldn’t be surprised to see Semler trading at a healthy premium to the Russell 2000 going forward.

Semler is a solid buy. I expect Semler to outperform the market in the years to come. I complete my position.