Update: Greatbatch Earnings-Strong Q2 Growth But Flat Sales Disappointed

Aug. 4.14 | About: Greatbatch, Inc. (GB)

Summary

Operating income was up 14% Y/Y and EPS grew 23%. Adjusted operating income and adjusted EPS improved 7% Y/Y, meeting consensus. Revenue was flat Y/Y, missing consensus.

The thesis has worked well. Waiting for the 10% dip paid off, and the stock returned ~40% in a year afterwards on improved margin focus and successful restructuring.

I reiterate my long thesis and set a target price of $50, offering a ~7% upside within 12 months. I advise full downside protection 10% below the purchase price.

Greatbatch, Inc. (NYSE:GB) reported strong earnings growth for the second quarter ended July 4, 2014 (SEC filing, earnings call, press release). Sales of $172.1M roughly flat Y/Y on a direct comparison as well as organic constant currency basis. GAAP operating income rose 14% to $19.5M. Adjusted operating income increased 7% to $23.8M. GAAP diluted EPS was $0.48, up 23% Y/Y. Adjusted diluted EPS totaled $0.60, up 7% Y/Y. Operating cash flow was $19.5M on improved operating income, compared to a cash drawdown of $1M a year ago caused by extraordinary items. Gross margin increased 60 basis points to 34.0% In exchange of longer agreements with customers to stabilize future sales, GB made some price concessions which were offset by lower performance-based sales force compensation. In June 2014, GB received CE Mark for Algovita, formerly known as Algostim.

In terms of segments, cardiac/neuromodulation sales fell 4% Y/Y to $80.0M, primarily on timing of shipments between quarters but also on the initial end of life impact for two legacy products. Sales in this segment are expected to continue falling on continued impact of the two legacy products, later mitigated by new product developments of GB partners. GB experienced double-digit growth in sales from its orthopaedic and vascular product lines on increased sales force productivity, marketing efforts and market growth, with sales of $37.9M, up 17% Y/Y, or 12% on constant currency basis. This strong growth was achieved despite negative impact from GB's Swiss orthopaedic facility consolidation. Portable medical sales fell $5.4M, or 24% Y/Y as GB minimizes sales of low-margin products. This negative sales trend is expected to continue a focus on margins prevails. With production expected to be transferred to a new Mexican facility, this segment is expected to grow sales and margins in the future. Vascular sales for the second quarter of 2014 increased $3.0M, or 25% Y/Y. Sales from energy, military and environmental segment grew 9%. In terms of forward guidance, GB remains focused on delivering 5% Y/Y revenue growth and 10% EPS growth. GB confirmed its previous 2014 guidance 3% to 6% organic constant currency revenue growth ($685M to $705M sales) and 7% to 12% adjusted diluted EPS improvement ($2.25 to $2.35). GAAP EPS target was also reiterated in the range of $1.94 to $1.99 per diluted share.

My July 2013 long thesis correctly asked investors to wait for at least a 10% pull which came within two months. A year later, the stock is roughly 40% up, including the current pullback. The margin improvement continues. However, as expected, sales are suffering due to this focus on margins. I am raising my target price to $50 per share, so the stock has a ~7% upside within a year. However, the long-term top line growth and current full prices in the healthcare/biotech small-cap sector are my main concerns. Therefore, investors should use full downside protection through options with strike prices roughly 10% below the purchase price.

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