TOP IDEAS: Focused on its orthopedic products for the aging population, Ergoresearch Ltd.’s (TSXV: ERG) efficiency gains in production are showing up in profits, with new healthcare products and services ready to launch.

Ergoresearch Ltd. (TSXV: ERG – C$0.23) had a turnaround year in fiscal 2016. The Company reported a small profit of about C$112 thousand compared to losing over C$7 million the year prior. Management’s focus on improving gross margins and reducing costs for its orthopedic products has set the foundation for profitable growth as a mass producer of custom-fit orthotics.

Ergoresearch Ltd. is based in Quebec, Canada and operates in the healthcare sector, in specific the orthopedic market, which is in full expansion owing to aging populations. It develops innovative orthopedic solutions and products often paid for by third-party health insurance coverage (both private and government) on behalf of the patient.

Ergoresearch has built up Quebec’s largest network, comprising of 70 orthotic clinics best known as "Equilibre” and is the leading manufacturer of "intelligent" foot orthotics and specialty orthotics. The Company is a trendsetter in creating durable medical equipment and software for the orthopedics market and holds may patents in this field.

Ergoresearch designed and commercialized"Webfit” technology, the first robotized custom-fit orthotics manufacturing software program. WebFit is a mobile Internet tool which enables the Company to offer services at what are known as "satellite” medical clinics to meet patients in person, at the clinic of their choice. According to the Company, WebFit is a unique concept in the field of foot orthopedics in that it offers orthotics clinics and laboratories, an innovative solution align with better patient pain management.

The Company’s WebFit technology recreates the architecture of the foot with the unique custom fit design of its orthotics based on each patient’s anthropometric measurements and pressure distribution data using a scanning technology. This process, which is patented by the Company, offers greater amplitude of range and pain management for optimal clinical performance.

Once the data from the patient assessment has been collected it is transmitted to Ergoresearch’s computational servers to create the optimal orthotic device using computer-aided design (CAD) software. The Company’s manufacturing process relies on computer-aided manufacturing (CAM) software and numerical control machine tools (NCMT), and offers the ability of mass producing custom-fit orthotics while ensuring reproducibility and precision.

It was about two years ago when Ergoresearch’s Management determined that their Company was at a crossroads. The Company built up a good orthotics business but the overall financial performance was weak due to production inefficiencies and continued losses from its homecare division. At that time the Company had lot of debt, too.

To try to turnaround around the financial performance, Ergoresearch decided to renew its focus in servicing the orthotics market, which had good revenue growth but, with the appropriate management attention and resources, could grow profitably. To achieve this, the Company’s Management divested non-core businesses, paid off all of its long-term debt and invested heavily in an Enterprise Resource Planning (ERP) system to integrate areas such as planning, purchasing, inventory, sales, marketing, finance and human resources in an effort to lower costs and build stronger operating margins for its orthotics business.

It is the culmination of Management’s efforts to turn around the financial performance of Ergoresearch that has attracted our attention. To begin fiscal 2017, the first quarter ended September 30th, 2016, the Company reported EBITDA of C$429 thousand (13% of sales), net income of C$204 thousand with earnings-per-share (EPS) of C$0.003. Cash flow from operating activities amounted to C$427,897 for the first quarter of fiscal year 2017. Revenues were down marginally in Q1 to C$3.4 million, mostly a result of the discontinued sales from its homecare products. Today, revenues from orthopedic prescriptions represent a significant percentage of the Company’s business, generated through the sale of Ergoresearch’s custom-fit foot orthotics. Historically the Company’s revenues are lower during the winter months.

The Company’s balance sheet at the end of Q1 for fiscal 2017 was in pristine shape. Ergoresearch is cash rich: C$8.1 million cash on hand (or in short term investments) and only a nominal amount of total debt.

Today the Investorfile blog see tremendous value in the shares of Ergoresearch and we have initiated coverage on the Company as one of Investorfile’s Top Ideas as a small cap value stock. The reasons we feel that Ergoresearch’s stock is worthy of this distinction are plentiful.

Our reasons include: At its last closing price of C$0.23, the Company’s stock trades at a 25% discount to its book value per share; The Company has a positive working capital balance of C$11.2 million, which equates to about C$0.15 per share; on an operational basis the stock currently trades at a multiple that is less than five times the Company’s underlying Enterprise Value (EV) to EBITDA ratio (if annualizing Q1 results). Based on the above valuation metrics we feel the current stock price of Ergoresearch is a bargain for a small cap growth stock.

Yes, the Investorfile blog sees value in stock price today, but just as intriguing are the potential growth prospects for the Company’s financial performance. From Management’s comments in Q1, sales trends are positive again. As sales rise we expect EBITDA as a percentage of sales to continue to strengthen which will improve profitability. Also, Ergoresearch is flush with cash and we feel at some point this cash will be deployed for an acquisition to grow the Company.

We also see opportunity for future revenue growth from new products and services. In the first half of fiscal 2018, Ergoresearch is expected to re-launch a new generation of a world-patented orthotic devices called "OdrA” which revolutionizes the treatment of pain associated with knee osteoarthritis. The product had been recently redesigned for the mass market at a lower price point. The Company has the exclusive rights to the OdrA product for Canada.

Ergoresearch recently announced that they will leverage the use its Quebec network of clinics by expanding its healthcare offerings to include the provision of services of sleep care. Currently four of the Company’s Equilibre clinics will offer this healthcare service with plans to expand to the entire network beginning with the region of Montreal in of spring 2017, according to the news release.

As a result of our analysis, the Investorfile blog recommends that small cap investors should take advantage of the current stock valuation levels and begin accumulating shares of Ergoresearch up to a price of $0.40. We forecast that sometime in fiscal 2018 the Company will achieve a quarterly revenue run rate of over $4 million ($16 million over 12 months) and earn EBITDA margins of 15%.

Based on our target price and forecast, a small cap investor can accumulate shares of Ergoresearch at an average cost-base of C$0.31 (the current book value/per share of the Company) which is a valuation less than six times EV/EBITDA, making this a small cap value wise investment opportunity. But the Company also has a significant cash position. Deployment of the cash for acquisition together with internal growth could drive the stock price of Ergoresearch shares way beyond our accumulation price target of $0.40.

We note at the end of fiscal Q1, Ergoresearch had 72.5 million shares outstanding. That is 3.66 million fewer shares than the year prior as a result of the Company repurchasing its shares. Ergoresearch has obtained the approval of the TSX Venture Exchange to proceed in the normal course of business to repurchase another 3.62 million of its shares over a 12 month period which began on November 11, 2016. The Company has already repurchased more of its shares since.

There is high insider ownership in Ergoresearch. The CEO owns a 21.1% stake in the Company. Currently Directors and Officers as a group, directly or indirectly, have an ownership stake which represents 46.7% of the currently outstanding common shares.

The Company’s website: www.ergoresearch.com

Author ownership disclosure: Yes: TSXV: ERG

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