Minimally invasive surgical approaches are not only here to stay in spinal care, they are likely to continue growing as a percentage of overall cases. That's great news for NuVasive (NUVA), as is progress toward the sort of operating margins that would normally be expected of a quality med-tech company. While a failure to get clean operating margins above 20% looms as a long-term risk for this company, as does competition, the ongoing consolidation in the orthopedics space may well make that somebody else's problem. I'm always a little leery of jumping into a story that is already up 50% over the past year, but I can't rule out the potential upside as investors covet growth stories in med-tech with an M&A angle.
Gaining Share In The Second Quarter
Second quarter results from the orthopedics space have been relatively lackluster, but NuVasive was a definite exception this time around. Revenue rose 15% as reported and closer to 17% on an organic constant currency basis, almost 8% better than the average sell-side expectation.
International sales were most impressive in terms of year-over-year growth (up 56%), but still make up less than 15% of the company's revenue. U.S. implant revenue rose almost 10%, with lumbar sales up 10% and cervical down 1%. U.S. monitoring revenue rose 15% while U.S. biologics climbed 18% on good pull-through from lumbar procedures and cross-selling efforts.
Adjusted gross margin improved more than a point from last year and showed a similar quarter-over-quarter improvement. Operating income rose by about one third, with the adjusted operating margin improve two points to 16%.
I cannot see how NuVasive didn't gain share this quarter. While management acknowledged ongoing low single-digit price pressures, Johnson & Johnson's (JNJ) spinal volume was up just 1% worldwide this quarter, while Zimmer (ZMH) reported "stable" results and Stryker (SYK) saw a low single-digit decline. Medtronic (MDT) has yet to report, but there is nothing in the competitor data or comments that would suggest a tremendously better result for this market leader, so I believe NuVasive has once again gained share within the minimally invasive spinal surgery market and the overall spine market.
Minimally Invasive Getting Bigger
While minimally invasive surgery, in one form or another, has been a talking point in the med-tech space for at least 20 years now, it remains a growth opportunity. Johnson & Johnson and Covidien (COV) continue to do quite well for themselves selling tools that facilitate minimally invasive surgery and Intuitive Surgical (ISRG) has built its business model in large part upon bringing more minimally invasive procedures to certain surgery types.
A minimally invasive approach is not appropriate for every spinal surgery case, but worldwide penetration has climbed to about 27% (and about one-third of U.S. cases). Compared to prostatectomies, hysterectomies, and gall bladder removal procedures, that's still a very low penetration rate. Again, allowing that this is an "apples to oranges" comparison, I believe MIS penetration in spinal surgery can reach 50% over the next five or six years and possibly go north of 66% over the next decade.
NuVasive has assembled one of the best portfolios of products to enable and facilitate minimally invasive spinal surgery, and I believe the company will continue to leverage this to gain share from more traditionally-focused companies like Johnson & Johnson, Zimmer, and Stryker.
Clearly there will be competition. Medtronic has long embraced the trend toward increasing penetration of MIS and has aggressively pursued NuVasive over patent infringement issues. Given its strong MIS position in general surgery, the importance of MIS is not lost on Johnson & Johnson and I don't expect this company to sit on its hands and cede share to NuVasive. It's also worth noting that NuVasive is still under-exposed to non-US markets that are likely to supply more growth in MIS penetration - increasing its marketing footprint in countries like Japan has been a key priority at NuVasive for some time, but it takes money to achieve.
Can NuVasive Get To OPMs Of 20%-Plus?
NuVasive continues to spend money to build its business, with more than 60% of every sales dollar going to SG&A and about 5% going to R&D. The company may actually be under-spending on R&D, but with strong recent product introductions like Precept (a pedicle screw system with a unique locking mechanism, improving the company's leverage to a $1 billion-plus markte), Bendini, and the Integrated Global Alignment systems, I can't say that they aren't getting good results for their R&D spending.
Stryker is roughly similar in size to NuVasive in spine (albeit with a different business mix), but generates operating margins in the mid to high 20%'s. Certainly that's not an entirely fair comparison to NuVasive, as Stryker benefits from a large integrated sales effort and can take advantage of bundling and cross-selling. Nevertheless, I think it supports the notion that better future operating margins are at least possible and plausible for NuVasive.
It may not matter if NuVasive management can get there on their own. A new wave of consolidation is running through the med-tech sector and NuVasive's leverage to the higher-growth MIS spine market makes it an appealing candidate. Neither Medtronic nor Johnson & Johnson would be likely (or perhaps even possible) buyers, but Stryker has made it clear that they're open to growth-by-acquisition in spine and even with the addition of Biomet, Zimmer is under-leveraged to this market. Either could be a buyer of NuVasive, with significant internal cost synergies (particularly sales and marketing) likely supporting a good premium.
The Bottom Line
NuVasive looks more or less fairly valued on a DCF basis (even with mid-to-high teens annual FCF growth), but med-tech investors have long favored EV/revenue for valuation. At less than 3.0x forward revenue, NuVasive seems undervalued relative to its growth, even allowing that its present-day profitability is weak. I suspect that some M&A speculation is already in these shares and the lack of DCF upside cools my enthusiasm, but I won't be shocked if NuVasive trades into the low-to-mid $40s on ongoing market share gains and takeover speculation.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
