I have spent the past couple of months pursuing a theme that I think makes a lot of sense. I believe that medical device companies that sell a high amount of consumables (relative to capital equipment) will continue to grow strongly despite some recent inventory destocking that may have hurt short-term sales performance. If you check out my holdings, you will see that I own four names that attempt to capture this thesis: C.R Bard (BCR), Somanetics (SMTS), Angiodynamics (ANGO) and Volcano (VOLC). Today, I would like to briefly discuss the investment case for the one I consider the riskiest, VOLC. I apologize for brevity, but I am recovering from shoulder surgery and am typing one-handed.
To back up, I identified a universe of about 80 companies that fall into the category of device manufacturers with highly recurring revenue. As I tempted to slim this group down, gross margin was one of the key attributes that I thought might highlight barriers to entry. The last thing I want in a down economy is a commodity manufacturer!
Volcano is a relatively new company, focused on cardiac care. Its main product is a system known as intravascular ultrasound (IVUS) that is used to help with the placement of stents. It competes in this area primarily with Boston Scientific (BSX), but this "David" is beating the "Goliath". I like the CEO, Scott Huennekens, who owns 2% of the company and takes a long-term view in developing the business. He has executed a couple of technology acquisitions as well as continues to invest heavily in R&D (16% of sales) as the company seeks to leverage its position in the catheter lab by integrating adjacent technologies and adding functionality.
Sales growth has been torrid, with 31% growth in 2008 and 34% in the March quarter. Gross Margin has expanded over the past couple of years from 61% to 63%. The company has a strong balance sheet, with almost $3 per share in cash and no debt. The company isn't yet profitable, but it's close, with analysts projecting a profit in 2010. I have noticed in the past when high growth companies become profitable, the investor base broadens. In any event, I find the valuation quite compelling at just 3X sales. My target for year-end is 4X projected 2009 sales, or $19 per share.(click on chart to enlarge)
I don't know if VOLC is an acquisition candidate itself, but I do believe that we will see some consolidation in Med-Tech. Most recently, Covidien (COV) acquired VNUS. In the case of VOLC, I would note that St. Jude (STJ) recently acquired a competitor in the functional measurement area (FM). The high recurring revenue business model of VOLC makes it attractive to any company that sells equipment to cardiologists. Given that VOLC works with everyone but BSX, though, I am not counting on this exit strategy. For those interested in learning more about the company, I would point them to the recent cover story of In Vivo magazine.
Disclosure: Long VOLC and long in Top 20 Model Portfolio