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Nanosonics and the risks of a company relying on one customer

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This sterilisation device maker has a new product but customer troubles could lead to short-term trouble.

When we initially upgraded Nanosonics to a speculative buy in 2014, we explained its competitive advantage: a new way of disinfecting ultrasound probes that was easier and more effective than the competition.

Around 14 patent "families" protect Nanosonics' trophon device. Most of these patents, however, only extend to 2024. With only six years before competitors can sweep in and copy trophon's success, we were anxious to see the next generation of technology that might lengthen Nanosonics' competitive advantage.

Thankfully, that day is here. Nanosonics has announced that its second-generation disinfection device - trophon2 - has received approval from the US Food and Drug Administration, with sales expected to begin later in the year.

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Management says the new device "reflects a completely new mechanical and software design".

While Nanosonics has hundreds of customers, only one truly matters - GE Healthcare. The company accounts for 66% of Nanosonics' revenue.

Unfortunately, GE is going through its worst losing streak in 125 years.

The company made a net loss of $US6 billion ($8 billion) in 2017. Investors are fretting over the company's $US57 billion of net debt and the stock has fallen 50% since December.

For all Nanosonics' successes in research, if GE ended its contract with the company sales would evaporate overnight and the stock would plummet.

GE has announced several measures to get back on track. The company has decided to retain its healthcare division but broader strategic changes could still have a trickle-down effect on Nanosonics.

To complicate matters further, GE will soon switch from being Nanosonics' distribution partner to being a capital reseller. Beginning in July 2019, GE will only make the initial trophon sale, and then Nanosonics takes responsibility for ongoing service to customers and the supply of consumable disinfectant cartridges.

With several forces now pushing and pulling on short-term sales, there's more room for negative surprises between now and August's full-year result. We reiterate our recommended maximum portfolio weighting of 2%. HOLD.

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Graham Witcomb is a senior analyst at Intelligent Investor (under AFSL 282288), owned by InvestSMART Group. Graham has a degree in psychology from the University of Sydney and is a Chartered Financial Analyst charterholder. He previously worked for one of the world's most successful professional gamblers, and joined InvestSMART in 2013 where he focuses on healthcare, insurance and transport infrastructure. To unlock Intelligent Investor stock research and buy recommendations, take out a 15-day free membership.
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