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Well, my initial 2025 model isn't even in the ballpark. I'm taking the opportunity to update the estimated fair value or modeled share price, which is now pegged at $18.83 per share.

AVITA Medical encountered yet more headwinds at the end of 2024. There's typically some seasonality around the end of a calendar year. Sometimes hospitals and drug industry middlemen buy more product to flush out annual budgets, sometimes they buy less in anticipation for the new year.

For the skincare specialist, there's typically slower growth in the fourth quarter as customer build inventory more slowly. AVITA Medical originally forecast Q4 2024 revenue of $23.3 million. It now expects to report just $18.4 million – not even close. That's lower than the Q3 2024 revenue output of $19.4 million, which itself marked a sharp recovery from an unexpected slowdown from Q1 to Q2.

What gives? Management gave the following rationale:

The revision in fourth-quarter guidance is attributable to a combination of factors, with slower-than-expected purchasing activity being the primary driver. Several of the company’s hospital accounts adjusted their inventory levels at the end of their fiscal year, resulting in reduced purchasing during December. While this type of behavior is common at year-end, the extent was more pronounced than we had anticipated, contributing to less revenue in the quarter. We expect normal purchasing activity for these accounts to resume in the first quarter, with deferred purchases from the fourth quarter rolling over.

That's not entirely unbelievable. Hospital systems are reeling from the aftermath of the coronavirus pandemic, encountering sharp losses and forced to make difficult decisions all around. Delaying purchasing decisions for ReCell is plausible.

The disappointment stems from AVITA Medical's inability to accurately anticipate headwinds from customers. To be fair, the business still achieved year-over-year growth of 29% using preliminary figures. That's still pretty solid.

The problem is CEO Jim Corbett once said "30% growth isn't enough." My initial 2025 model anticipated full-year revenue of $145 million. AVITA Medical now expects just $103 million at the midpoint. The good news is I think management is finally underestimating performance. The bad news is my initial model is pretty inaccurate. The so-so news is I'm taking advantage of the share plunge to build my position.

The Trade

AVITA Medical is considered a Growth (Quality) position. I purchased 104.93 shares at $9.53 per share on January 8, 2025.

Scenario Analysis

My modeling is based on valuing assets, contextualizing competitive landscape dynamics, and weighing the probabilities of favorable and unfavorable scenarios. This trade was driven by the following considerations.

Guidance and math only work one way

Management's guidance could be wrong.

But… if the business is expected to achieve GAAP profitability by Q4 2025, then it needs to achieve a significant level of revenue. My model now expects Q4 2025 revenue of roughly $35 million – not quite enough to achieve profitability.

It is enough to exit 2024 with an annualized revenue run rate of $140 million. And that's before stable vitiligo launches in 2026, which should be a significant growth driver.

Stable vitiligo is a key long-term growth driver

Although the ReCell System has earned U.S. Food and Drug Administration (FDA) approval in stable vitiligo, the company isn't launching until it has reimbursement in place. To achieve that milestone, AVITA Medical is conducting economic analysis studies to make insurer decisions easier and reimbursement rates higher. Hopefully.

The total serviceable addressable market (SAM) opportunity in stable vitiligo exceeds $750 million. It could exceed $1 billion if new treatments, such as Incyte's Opzelura, help more patients with vitiligo achieve stability. That's a requirement to make them eligible for treatment with ReCell.

Cost of capital is a significant risk

AVITA Medical was too rigid in avoiding dilution to raise capital. That will end up hurting the business in 2025. The business needs more cash, but the stock price of $9 per share is sharply lower than the recent peak of $20 per share. Management should've issued a public stock offering to raise capital. Now, its hands are tied. It already raised debt, so it can either raise more debt or accept more dilution with smaller offerings.

Companies will have an exceedingly more challenging time raising capital in 2025 and 2026 given current interest rates and U.S. Treasury yields, which are quietly a more important determinant for the corporate cost of capital.

How am I approaching this position?

AVITA Medical has a target allocation of 15% in my portfolio. It's expected to be one of my core positions to add in 2025 alongside Relay Therapeutics and Arrowhead Pharmaceuticals.

I might grow my position in AVITA Medical by $3,000 to $5,000 total in 2025, including this $1,000 Finch Trade. I will take the company's dwindling cash position into account for future purchases, which aren't a near-term priority for Q1 or necessarily 1H 2025 portfolio transactions.

Outperformance Scenarios

Investing in individual stocks can be reduced to a simple question: "If I invest $1 in this individual stock at this price, will it outperform an equal passive investment in the S&P 500 at this level?"

If you keep emotions and expectations in check, then you might be surprised to learn you don't need to swing for the fences.

Here's how AVITA Medical shares will need to perform for the money invested in this Finch Trade to outperform passive investing in the S&P 500 or biotech benchmarks in the next five years.

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Assumptions:

• The S&P 500 index gains 10% per year with dividends included – its historical average since 1990.
• AVITA Medical averages 14.2% dilution per year in the next five years – equivalent to a standard 17.5% dilutive event every 18 months. This is the historical average for precommercial and newly commercial drug developers.
• S&P 500 closing level on January 8, 2025 = 5,836
• AVITA Medical closing price on January 8, 2025 = $9.53 per share

Margin of Safety & Allocation

AVITA Medical is considered a Growth (Quality) position. The current modeled fair valuation for the company based on my 2025 model is below:

• Market close January 13: $8.82 per share
• Modeled Fair Valuation: $21.05 per share
• Allocation Range: Up to 15%

AVITA Medical reported 26.218 million shares outstanding as of November 4, 2024. The modeled fair valuation above assumes 30.150 million shares outstanding, which is equivalent to 15% dilution.

Further Reading

• January 2025 press release announcing preliminary 2024 revenue and 2025 revenue guidance
• November 2024 research note analyzing Q3 2024 operating results

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