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Summary

  • Cyberonics reported that it first quarter results were off to a slow start.
  • Despite the disappointing results, the company continues to back its full year outlook.
  • The valuation is fair amidst the strong historical reported growth and strong balance sheet.
  • That being said I am worried about potential above-average risks in this story.

Investors in Cyberonics (NASDAQ:CYBX) were not very happy with the company's first quarter sales which fell short compared to consensus estimates. Despite the softer start to the fiscal year, the company remains committed to its full year earnings outlook.

I am in doubt about the business, its prospects and the valuation in relation to the risks out there. I remain cautious and stay on the sidelines.

A Look At The Business

Cyberonics presented itself recently at the William Blair conference in June, stressing its leadership position in medical devices used for patients suffering from epilepsy.

Since inception in 1988 some 70,000 patients have benefited from its solutions, receiving a total of about a 100,000 implants. While the company still derives about 80% of its sales from the US, international sales are increasing much quicker. As such, Cyberonics will slowly reduce this percentage and dependency going forwards.

The company stresses the importance and implications of the disease with over 9 million people suffering from epilepsy in the US, Europe and Japan. Worse, the mortality rate of this patient group is 25-40 times that of the general population, underlying the need for a solution.

In that light a solution which costs about $20,000-$25,000 per implant seems perfectly viable as it could improve the lives of those affected by the condition significantly. Cyberonics's Vague Nerve Stimulation therapy (VNS) is just such a solutions having a generator being placed into someone's chest sending electronic pulses to the neck and the brain.

Soft Start To The New Year

Cyberonics posted first quarter sales of $72.0 million last week, a 6.8% improvement compared to the comparable period last year.

Management was not really happy with the results, citing that overall revenues fell about a million short to its expectations on lower than expected results in the US. Sales in the US were up by 4.4% to $58.8 million as international sales rose by 14.5% to $13.2 million in constant currencies.

The company continues to operate with very strong gross margins of 91.1% of sales. Actually Cyberonics managed to boost margins by another 60 basis points compared to last year. Overall operating spending fell compared to last year, partially the result of $7.4 million in settlement payments which the company made last year.

As a result net earnings rose by more than 55% to $13.5 million, with earnings per share being up by nineteen cents to $0.50 per share. Adjusted earnings, which are based on non-GAAP accounting came in three cents higher thereby missing consensus estimates by two cents.

2015 Guidance

Despite relative softness in the first quarter results, Cyberonics continues to forecast annual sales of $300-$307 million for this year. At the midpoint of this range, revenues are seen up by 7.5% compared to last year.

Adjusted earnings are seen between $62 and $64 million which translates into $2.33-$2.39 per share earnings estimate. This was exactly in line with the company's previous outlook and in line with consensus estimates.

Valuation

At the end of the quarter, Cyberonics held some $149 million in cash, equivalents as well as short and long term investments. The company held no debt, resulting in a very comfortable net cash position.

With some 26.9 million shares outstanding at the end of the quarter, and those shares trading at $57 per share, equity in the business is valued at $1.53 billion. This implies that operating assets are valued at around $1.4 billion.

This values the company's operating assets at about 4.6 times anticipated earnings and 22-23 times anticipated non-GAAP earnings.

A History Of Growth

Cyberonics has posted impressive growth over the past decade increasing its sales from little above $100 million in its fiscal 2005 to anticipated sales just north of $300 million this year. This has resulted in average revenue growth of 11-12% per year over this time period.

After reporting losses upto 2008, Cyberonics has posted profits ever since with earnings growth seeing a steady increase over time. This transition from losses into rapid and profitable growth has occurred without causing dilution in the ownership base of old shareholders.

Those shareholders have seen a bit of volatility over this time period. Shares peaked at $40 in 2005 after which they fell to lows of $15 in the period 2007-2009 before a steady recovery pushed shares to highs at $73 at the start of this year. Ever since a 20% sell-off has occurred.

Final Recommendation

I am in doubt about Cyberonics. On the one hand I recognize the strong balance sheet, strong and solid historical growth and very fat profits at the moment. This makes the valuation multiples in the low twenties after backing out the net cash holdings perfectly justifiable.

That being said the first quarter was a bit soft amidst slow domestic demand, although the company continues to back its full year outlook. This cautiousness as displayed earlier this year has pushed shares some 13% lower year to date.

Normally I would be quite inclined to buy into a big correction in a bull market, yet this time I am not so certain. Essentially Cyberonics relies on a single market and its products offer little diversification within its current business model. This makes shares very vulnerable for competition and potential adverse FDA rulings as comments on internet forums about its solutions are mixed at times.

As such I don't see enough risk-reward potential at an already ¨full¨ valuation while an investment might carry above-average risks.

Source: Cyberonics - Why I Am Still Not Buying Into The Recent Correction