Net Sales came in at SEK7.4m, -14% Y/Y, well below our estimate of SEK12.9m (-43% deviation). We think the reason for the deviation is twofold. First is seasonality appears to be smoothing out, with H2 strong rather than just Q4. Due to this, we wrote in our last update that our Q4 estimates might be slightly exaggerated. Our estimate turned out to be excessive. The second reason for the deviation is that in Q4’21, the Company had an especially strong quarter, with 49% of the net sales preannounced via orders with expected delivery in Q4’21. This quarter the same figure was only 15%. EBITDA came in at SEK0.1m (deviation of 98%), corresponding to an EBITDA margin of 1% (14% last year). Thus, well below our estimates of SEK 4.8m. We expected an EBITDA margin of 37%. The main reason for the deviation is lower sales and higher OPEX. However, better gross margin offset this slightly.

While operating results were weak, cash flow from operations was strong. However, this is mainly due to short-term liabilities increasing by SEK3.8m Q/Q and SEK10.3m Y/Y. We believe this comes from prepayments for the H1’23 order book. Thus, we expect this to reverse in the coming quarters.

Gasporox has released some news revolving around the US market during the quarter. To capitalize on the US opportunity, the Company signed three new distributors in the US to sell instruments and hired a local consultant to help them establish a presence in the US. Moreover, Gasporox realigned its sales force to focus on geographical distribution rather than a segment focus. Additionally, Gasporox received a patent in the US for its laser technology, including the ability to measure the package’s dimensions and gas content simultaneously. In contrast, earlier versions could only measure the gas content. This patent will likely open up more opportunities in the US market for Gasporox.

Considering Gasporox’s size, we have not thoroughly modeled the US market. However, we think Gasporox has the potential to increase the growth rate and note that the US has the highest per capita health spending at cUSD13.000 in 2021 (c18% of GDP). The latest figures available for comparison are from 2019, where the US per capita health spending was cUSD11.000, compared to the second highest of cUSD7.000 (Switzerland) and the OECD38 average of cUSD4.100. FMI estimated the US market for headspace analysis instruments to be the largest in 2021 at cUSD26m (cSEK270m), though this figure only includes at-line instruments used in pharma. We expect to hear more about the US market in future interim reports.

This brings us to the pushback we get from potential investors - what is the market size, and why can Gasporox sell at such a premium? FMI, in the same report as above, estimates the market for Global Sterile Parenteral Containers Headspace Gas Analyzers to be cUSD66m (cSEK690m) in 2021. Considering Gasporox’s revenue for 2022 of SEK21.5m, it would already have a market share of c3%. Moreover, we forecast Gasporox’s revenue to grow to SEK103m by 2027, implying it would have a c9% market share, assuming FMI’s projections hold. While we do not find those assumptions unreasonable and actually think it is positive that an entrant cannot be profitable with a c3% market share, we believe higher standards for CCIT testing drive a TAM expansion.

Historically, CCIT testing was done with probabilistic tests where a selection of the products produced was tested. If these met the threshold, it was considered safe. Probabilistic methods are dependent on technique, sample preparation, and operator variability. This results in them being time-consuming and unreliable. With the help of new guidelines - USP1207 and EU GMP Annex 1 in particular - the industry is moving towards deterministic solutions where the specific product unit can be determined to be correctly manufactured. The higher standards require that many drugs be tested using deterministic solutions. For example, the current EU Annex 1 guidelines stipulate 100% integrity testing for containers closed by fusion, such as glass or plastic ampoules, and for any parenteral products. Any company can determine to test all its products regardless of statutory requirements. Our understanding is that most companies switching away from the blue die test do so because of the improved sensitivity of the test or because of regulation.

The probabilistic testing methods are mainly destructive and could be done with at-line testing. However, at 100% testing, high throughput of 400-600 tests per minute is required, and at-line testing is simply impractical for most drugs except for very low-volume, high-value drugs.

The USD66m market size provided by FMI only includes at-line instruments. The move to in-line testing will increase the market as more units are required. This is because the at-line equipment can serve many different lines while the in-line solution can only service the relevant production line. If we assume one at-line instrument can do 2-6 lines, solely moving to in-line would increase the market by 2-6 times. Moreover, the number of sensors per line could also increase depending on what the customer wants to measure.

The common solution for 100% CCIT testing is done using vacuum chambers. The main disadvantage of this method is that each chamber can only test one part per chamber. Large-scale machines with up to 50 chambers arranged in a carousel are used to boost productivity. These have higher maintenance requirements and require more manufacturing space. Conversely, Gasporox’s in-line options have a compact form factor and high throughput (up to 600 units per minute), which we believe should attract potential customers.

To our understanding, blue die tests have been the industry standard as its extremely cheap and easy to set up. However, as mentioned earlier, it lacks reproducibility and is dependent on sample preparation, among other things. Thus, the industry is moving away from these tests. From the industry participants we have talked to, we heard that Contract Manufacturing Organizations (CMOs) are very price sensitive. While Gasporox charges a premium compared to the destructive tests, we found that Gasporox’s competitor, which uses a similar laser-based technology, Lighthouse Instruments, charges about 50% more than Gasporox. Thus, while Gasporox is more expensive than the blue die tests, it offers a competitively priced product within its technology niche.

Combining the higher number of sensors required with Gasporox’s higher price point, we think the in-line pharma market alone could be worth between SEK6.5bn-SEK19.5bn. Estimating the market size by solely moving to in-line and not accounting for different sales prices or the number of sensors, we think Gasporox’s TAM could be cSEK1.3bn-cSEK4.0bn. Hence, significant growth potential remains. Moreover, this does not include the potential for food or beverages.

We also found that contract labs could be quite a price sensitive from conversations with industry participants. However, the labs depend more on the business case and, to some extent, if the purchase decision maker has a science or a business background. The versatility of the pharmaceuticals and package formats the equipment could test was also important. Apparently, some labs found it hard to find a supplier with supplies available or who responded to customer inquiries, which also drove purchasing decisions. We have heard from Gasporox that one of its advantages is that it can ship products fast upon customer requests. These conversations confirmed that Gasporox is an agile and responsive organization that can deliver quickly.

We are a bit surprised to learn that CMOs and contract labs are somewhat price sensitive, as our initial understanding was that that was not the case. However, Gasporox is cheaper than lighthouse, which should help with sales for customers looking for a laser-based solution. However, we do not know how well Gasporox stands compared to other technologies, such as a vacuum-based test. We also do not understand why potential customers chose one technology over another.

Trying to answer these questions, we have learned that all the testing equipment is built to test pharmaceuticals, but each has pros and cons; some fit better for certain pharmaceuticals than others. For example, a laser works better on drugs that must be stored in frigid environments as the temperature changes would contract and expand the rubber in a vacuum test, potentially compromising the seal. The preferred technology can also differ based on the customer type. For example, labs might prefer helium tests, which are very sensitive and used for product development and validation, while manufacturers might prefer a different technology. See the table below for an overview comparison between other test methods. We will research this further to understand better customers’ price sensitivity and what drives them to one technology.

After visiting Gasporox’s production facility, we have increased confidence in our investment case. The investment case is built on Gapsorox earning high incremental returns as it extends its product range to fit more form factors. While visiting Gasporox’s facilities, we learned that for the GPX1500 to serve another format, only the highlighted part needs to be changed. Sometimes this only requires the shape of the attachment to be upgraded. Earlier, we thought the entire machine had to be redesigned while keeping the core technology the same. We also learned that each new form factor requires a new set of reference tests, which should result in high-margin after-market sales.

Thus, we believe Gasporox has only scratched the surface of what is achievable in terms of after-market services and product line extension. Possibilities include extended warranties, reference tests, yearly calibration services, etc. The pricing power within these segments is high, and the pharmaceutical industry demands yearly calibrations for quality assurance. However, our channel checks indicate that the southern part of Europe is less likely to buy a warranty and prefers to pay as needed, while northern Europe is the opposite. We do not have an accurate picture of where most of Gasporox’s sales occur in Europe, but this could be a potential headwind. Lastly, although many formats are visually similar, they might require a different attachment from Gasporox, as the laser light might bounce differently depending on the form factor.

While we believe Gasprox could show a very high ROIC once it becomes profitable, this is still to be determined. However, we are encouraged that the gross profit to asset ratio keeps improving and stands at 38% for 2022.

Gasporox tends to focus its R&D efforts on solid customer requests, where the customer pays for the R&D while Gasporox retains the rights. To demonstrate Gasporox’s VialArch, the Company developed a Hurricane system, which tests and sorts products in an automated matter but outside the production line. The system is well suited for testing larger batches. This demonstration system garnered enough attention from potential customers that Gasporox is now evaluating adding it to its product portfolio. The first system was shipped to an American customer during the fourth quarter.

Gasporox’s detailed review of the Food market is complete, and Gasporox concluded that there are significant synergies between the food and pharma market with many overlapping distributors and similar products. Therefore, Gasprox will realign its salesforce to regional distribution and achieve synergies between the two segments. We believe the expansion will be done in successive steps, following Gasporox’s traditional expansion based on customer inquiries. Gasporox has two customer projects towards the food segment for an inspection module called AutoMAP. The AutoMap is expected to launch in 2023. As we noted in our initial coverage, the food market is significantly larger than pharma but has lower margins. While we estimate 1/3 of sales are already towards the food segment, a successful expansion of food markets could result in accelerated growth.

To date, Gasporox has press-released orders set for delivery in H1’23 worth SEK8.5m. Based on the strong order book, we have increased our H1’23 sales estimate to SEK12.3m from SEK9.7m.

When we initiated on Gasporox, the prior two Q4s (Q4’20 and Q4’21) had shown significant revenue acceleration compared to the rest of the quarters of the same year. According to management, they had realized customers had budgets left over, and thus, if inventory was available, it was an easy sale for Gasporox. We thought Gasporox had not fully utilized this and expected Q4’22 and Q4’23 to show a higher growth rate than the rest of the quarters in that year. However, it seems like this will no longer be the case. Therefore, we have reduced our Q4’23 estimate to SEK10.0m from SEK11.9m, resulting in a lower growth rate in H2 versus H1, while H2 remains the stronger half of the year in absolute terms. We still expect Gasporox’s quarterly financials to fluctuate based on order flow, and we want to reiterate that investors should not emphasize the quarterly projections or results in isolation.

We believe that Gasporox’s long-term story is still intact. The Company continues to develop its product portfolio and expand geographically. Along with more attention paid to the food segment, we believe the Company is doing everything right to build long-term shareholder value. Thus, we have increased the growth rate by 1pp to 45% from 44% for 2023 and 5pp to 40% from 35% for 2024. We have also increased our OPEX estimate slightly to account for expansion costs. However, due to the a lower base, our net sales estimates are reduced by 17%-20%, and our EBITDA estimates are reduced by 25-68% for 2023e to 2025e.

Combining the US expansion bearing fruit and the expansion towards the food segment, while the underlying business momentum increases due to the strategic shift made two years ago from exclusive agreements to more complete modules, we think Gasporox could surprise on the upside. However, we need more data points to get comfortable with such as scenario.

Our new fair value range is SEK12-45 with a Base case of SEK25 per share. The old range was SEK13-54 with a Base case of SEK31 per share.

On a peer basis, Gasporox is trading at a discount on EV/S for 2022e-2024e while at a premium on EV/EBITDA and EV/EBIT over the same period. While we believe Gasporox could become highly profitable and show a significantly higher EBIT CAGR versus sales CAGR, the Company is still unproven regarding sustained profitability and margins. Thus, we do not think the Company should fetch a premium on an EBITDA or EBIT basis. However, we are a bit surprised the Company is trading at a steep discount to peers on an EV/S basis as we expect Gasprox to show higher growth rates than the median peer.

Recently, Redeye has made a substantial update to its rating model. As a result of these changes, companies now need to meet a higher threshold to receive a favorable rating from Redeye. However, as Gasporox has developed favorably, especially on its financial profile, the Company’s score has increased from People: 3, Business: 3, and Financials: 2 to People: 3, Business: 3, and Financials: 3. Consequently, we have changed the discount rate to 10.5% from 11%.