For a company with relatively modest underlying growth trends, C.R.Bard (NYSE:BCR) has generated a fair bit of enthusiasm on the Street for the enhanced growth prospects bought through M&A and the royalty stream from Gore. Among the acquired products, investors are particularly keen on the prospects for the Lutonix drug-coated balloon and management's comments on the earnings call only seemed to add more confusion to already noisy situation. Bard is not a particularly cheap stock at these levels and the company is going to need better organic growth and clear differentiation in drug-coated balloons to support further gains.
A Lot Of Moving Parts For A Basically In-Line Quarter
Bard reported 8% revenue growth for the first quarter, good for a very slight beat relative to sell-side expectations. Organic growth was more on the order of 3% and based on the other med-tech reports seen to date, that looks to be on the weaker side of ordinary.
The vascular business was nearly flat on an organic basis, as the company saw double-digit weakness in peripheral stenting. Neither Abbott (NYSE:ABT) nor Johnson & Johnson (NYSE:JNJ) typically talk about peripheral stenting in great detail, and Covidien (COV) reports tomorrow, but it would look as though Bard has continued to lose share here.
Bard also appears to be losing share in hernia fixation to Johnson & Johnson and Covidien, as sales here dropped 12%. Overall surgical sales were up 3% on an organic basis, though, and the 3% growth in overall soft tissue (helped by double-digit growth in synthetics) would seem to be keeping pace with its larger rivals in overall soft tissue repair.
Oncology was up 6% on an organic basis, and Bard saw 11% growth in PICCs, a business that supplies about one-eighth of the company's revenue. Bard dominates the PICC space, and given the 5% growth seen at AngioDynamics (NASDAQ:ANGO) for the quarter, it looks like that share is very much intact. Bard also reported flat organic sales for the urology business.
Margins were basically okay. Gross margin was about a half-point better than expected and a point higher than last year, but Bard spent a lot of that on higher SG&A. Operating income was up 10% and in line with expectations, though the operating margin was a little better than expected.
The DCB Situation Isn't Getting Simpler
I believe that the weakness in Bard's shares had everything to do with confusion coming out of the earnings call regarding the company's drug-coated balloon (or DCB) program. The Lutonix balloon is a key growth opportunity for the company, as expectations are that DCBs can grow into a $1 billion-plus revenue opportunity for Medtronic (NYSE:MDT), Covidien, and Bard in the coming years. If Bard's first-mover status can lead to just one-third share of that pot, that would represent an incremental 10% to revenue (though not truly incremental as almost everybody already factors DCB sales into their models).
The key problem is that nobody really knows how the Bard DCB stacks up compared to Medtronic's Admiral. Medtronic's trial showed an improvement in target lesion revascularization (or TLR) at six months, while Bard's did not. What's more, Medtronic recently presented data on 12-month patency but Bard has not, even though they have the data. Making matters worse, Bard management's comments suggested that 12-month data didn't improve over six-month data.
There are a lot of complicating factors here. First, Bard ran a considerably more rigorous trial design than is the norm, including a different definition of TLR and blinding the follow-up analysis/interpretation. Second, Bard really wants its 12-month data published in a major journal and releasing the data early would compromise that effort - Bard believes that getting the "seal of approval" from a major journal (like NEJM) will be important in validating the different trial design and supporting the significance of the results.
The bottom line would seem to be this. Medtronic's data in the superficial femoral artery are certainly competitive, with 89% patency, but the fall-off from 89% to 78% between one year and "one year plus one month" and the overall results certainly room for competitors. Medtronic's data will likely be stronger on primary patency and TLR, but Bard's trial was more rigorous (blinding the doctors at follow up) and almost 18% of the patients in Bard's trial had severe calcifications versus 8% in Medtronic's trial and DCBs are known to not work nearly as well in these patients. All told, Bard's DCB is likely to be quite good, and about six months ahead of Medtronic, but the company may well be punished by the market (initially at least) for running a more rigorous trial that makes head-to-head comparisons much more challenging.
There is a risk that Medtronic may be able to bypass a panel meeting, which would chew into that six-month lead that Bard enjoys. It's likely to be a two-horse race for some time, though, as Covidien is looking to enter the U.S. in 2017 and Boston Scientific (NYSE:BSX) may not launch a DCB in the U.S..
Spending Is Real, But Better Growth Is Still A Hope
Bard has spent something on the order of $1 billion over the last 30 months to improve its growth potential, and has been increasing SG&A spending ahead of revenue growth to support that potential. Here of late, the company does not have much to show for it in terms of above-average/above-peer organic growth.
It is still too early to condemn those moves, as Medafor, Rochester, and Lutonix have yet to show what they can do in Bard's hands. So while the bears are technically correct that all of that spending hasn't helped present-day sales growth, it seems very premature to say it won't start providing a boost in 2015/2016 and beyond.
I'm looking for roughly 4% long-term revenue growth from Bard, which is admittedly not all that spectacular. There could be upside from the company's DCB and synthetics businesses, but I have some concerns about the inherent long-term growth potential of many of the businesses. I am looking for greater margin leverage, though, and I believe improved FCF generation can add a couple of points to the FCF growth rate.
The Bottom Line
I do think the market overreacted to the comments Bard management made about DCBs, but that doesn't mean this is now an exceptionally cheap stock. A discounted cash flow model suggests mid-to-high single digit annual total return potential from here, and the shares are trading close to 3.5x forward revenue which seems more than fair for the organic growth profile. I might be more interested at or below $130, but there are better options today in larger med-tech.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.