Avita Medical shares (ASX: AVH) have plunged 37% this year. Avita is a single product company with their RECELL system which is an innovative burn treatment device which creates Spray-on Skin.

As expected, no-moat Avita received regulatory approval for an updated version of its current RECELL device last week that simplifies the user interface. The timing is no surprise, as Avita had flagged that the updated device should launch on May 30, 2024. As such, we make no changes to our earnings estimates, and our $5.40 fair value estimate remains intact. Shares are currently trading at $2.70.

Shares remain undervalued. We expect Avita’s international expansion plan to help provide a path to profitability by late calendar 2025, broadly in line with management’s expectation of hitting the milestone in the third quarter of 2025.

However, a quicker transition to profitability is unlikely, and there is a wide range of potential outcomes based on the success of its vitiligo indication, which is reflected in our unchanged Very High Uncertainty Rating. We expect Avita’s first cash flow positive fiscal year to be 2026. Despite revenue falling sequentially and costs stepping up in the first quarter of 2024, we are fairly confident Avita won’t require additional funding, with USD 68 million in net cash and marketable securities as of March 31, 2024.

What gives us confidence in Avita’s self-sufficiency is that 46 new hospital accounts are using RECELL for full-thickness skin defects are likely to be added in the second quarter of 2024 based on approval timelines. This compares with Avita opening 51 new accounts in 2023, after launching in June 2023, and adding 22 accounts in the first quarter of 2024, highlighting the expected strong growth.

In addition, January 2024 had abnormally low burn admissions, 20% lower than the previous three. We also expect Avita’s strengthened sales team to drive growth from both PermeaDerm and Avita’s improved RECELL device, which received approval. Finally, the company is on track to sign distribution arrangements to sell RECELL more widely in Australia and Europe later this calendar year.

Business strategy and outlook

We expect Avita’s RECELL to pose a significant challenge to the standard of care for larger burns, currently a skin graft sourced from elsewhere on the patient’s body. We believe Avita will be successful based on the product’s clinical performance, ease of use and relative price point. RECELL creates Spray-on Skin within 30 minutes from a skin sample, typically less than 5% of the size required in a graft. It has been clinically demonstrated to heal the burn site as effectively as a skin graft without creating a large donor site wound.

Despite the technology in Avita’s RECELL system being in use since the Bali bombings in 2002, the product has had limited commercial success as it entered the market as an investigational device. This limited the reimbursement and take-up of the product. RECELL relaunched in the US following randomized clinical trials and Food and Drug Administration approval in late 2018. Currently, it's approved for treating second- and third-degree burns in paediatric and adult patients.

The treatment of severe burns in the US is concentrated across the 136 burn centers, making commercial rollout of RECELL straightforward. Of the approximately 14,000 adults with second- or third-degree burns treated at these burn centers each year, we estimate Avita could ramp up to 34% share or 4,800 patients per year by fiscal 2026. The cost of RECELL compares favorably with a skin graft in this setting, as RECELL has a list price of USD 7,500 per single-use unit versus the USD 17,000 to USD 20,000 cost of a skin graft. It also has the benefits of shorter length of stay and fewer additional procedures.

Outside of burn centers, the opportunity set is far more fragmented and because the burns are less severe, the cost of skin grafts average USD 2,000. As such, we expect limited take-up outside of burn centers, reaching 3% by fiscal 2031. Avita has received regulatory approval for an updated RECELL device that makes handling easier in a regular hospital environment. We expect the company will seek to justify reimbursement on a holistic cost of treatment and roll out the updated version in second-half fiscal 2022.