By David Sterman
It's important to maintain watch lists of your favorite stocks. Even after they've had a great run, it pays to make sure you check in from time to time to see how they're doing. And with the stock market zooming and plunging during the past few years, these stocks sometimes can fall right back into bargain territory.
One of my favorite healthcare stocks -- Nuvasive (NUVA) -- falls into this category. Shares had zoomed from $25 to $34 this summer, but the August market swoon has pushed it right back under $25 again. I first profiled this maker of spinal surgery equipment back in the spring of 2010. Since then, a volatile stock chart has created a set of fresh entry points, along with several opportunities for profit-taking.
I wrote in 2010: "Nuvasive has come up with a set of products to make back surgery a far less onerous experience." The company's minimally-invasive Maximum Access Surgery platform is used for spinal fusion surgeries. I also noted: "Hundreds of new doctors are being trained on the company's equipment every year, which is fueling white-hot sales growth for the company. And we may only be in the middle innings."
Since then, growth has cooled from the 30% to 50% rates seen in previous years down into the low teens for both 2011 and 2012. But it's not that the medical community has cooled to the company's suite of products. Instead, reimbursement changes in health care have led to a pause in the adoption of newer technologies.
Forgetting the recent market swoon, it's fair to wonder why shares also took big hits last October and again this February. The answer can be found on the income statement, because management is spending more heavily than many would like. Operating margins only reached 6.7% in 2010 even though many medical devices boast of far higher margins at this point in their life cycle. "Operating leverage continues to be a difficult balance as the company is making investments, which will obviously pay off in the long-run given NUVA's current market share relative to innovation dominance within spine" write analysts at Barrington Research. They add the company "should be spending as much if not more given the market share and technology differential mentioned above." The firm has a $40 price target for the stock.
Since Nuvasive is in heavy investment mode, it's not helpful to measure its value relative to profits. Shares trade for about 20 times this year's projected profits, but the multiple would be much lower if management was running the business to realize margin potential and not sales growth. A better metric may be price-to-sales. While rival Intuitive Surgical (ISRG) trades for more than eight times projected 2011 sales, Nuvasive's price/sales (P/S) multiple is less than 2.
Make no mistake, the company's heavy investments are not fully reflected in top-line growth just yet. Insurers have sometimes balked at reimbursement, leaving patients that don't have the out-of-pocket funds to live with back pain. Yet the company is pressing the case that the upfront expense of surgery using its tools is actually cost-effective when compared to the long-term costs of treating chronic back pain.
It increasingly appears management will wrap up the heavy slate of growth-related investments in the next few quarters, which should subsequently enable Nuvasive to generate more cash from its sales base. Analysts at Merrill Lynch predict operating margins will almost double from 2010 to 2013 to around 13%. They also figure shares will trade up from a recent $24 to $40 as this plays out. Goldman Sachs figures free cash flow, which will likely be modestly negative this year, should reach roughly $60 million ($1.48 a share) by 2013. This leads them to a discounted cash flow-derived price target of $36.
Shares have also been pressured by a lawsuit filed by Medtronic (MDT) regarding patent infringement. Analysts think Nuvasive has a strong case to make in the trial, which just got underway, and think a positive legal resolution could be another catalyst. Indeed, Nuvasive is counter-suing, alleging Medtronic has used its patented technology. Nonetheless, if Medtronic prevailed, Nuvasive would likely owe damages and royalties.
Nuvasive's sales base has shot up from $100 million in 2006 to likely more than $500 million this year. Intuitive Surgical, which had a big head start on Nuvasive, is already up to $1.7 billion in annual sales. Both companies are considered to possess the strongest technology platforms in the spinal surgery category. It may only be a matter of time before Nuvasive's sales base starts to catch up to its larger rival.
While Intuitive Surgical is now valued at around $15 billion, the recent sell-off in Nuvasive's shares value the company at less than $1 billion. This means Intuitive has roughly three times Nuvasive's sales base, yet carries 15 times the market value. Nuvasive's stock should eventually rise to narrow this gap. If they were to reach the price targets near $40 that I previously mentioned, then we're talking about a gain of at least 40% from the stock's current price.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.