Abiomed: A Heartbeat Away From Next Uptick

Oct. 26, 2020 3:53 PM ETAbiomed, Inc. (ABMD)ABT, TMO13 Comments

Summary

  • Shareholders have enjoyed +113% gains since the selloff in March, however, volatility to the downside has crept in since August.
  • Revenues and FCF have grown at a CAGR of ~30% and 48.04%, respectively, over the 5-year period to date.
  • The stock had strong support to August, where it bounced off the support line 6 times in an ascending uptrend, before breaking support in a downtick to today's trading.
  • Since, a descending triangle setup has formed, meaning that there is a chance a large pullback may occur, presenting an exciting entry point.
  • We remain bullish on Abiomed, and are eagerly awaiting Q3 results for guidance and to update modelling to reflect value creation for shareholders.

Investment Thesis

Abiomed Incorporated (NASDAQ:ABMD) shareholders have enjoyed 113.4% upside since the selloff in March, and the company looks to be in a pivotal spot just prior to Q3 earnings. The maker of the Impella heart pump series has claimed its market share within the circulatory support domain, notwithstanding a year of controversy. Back in 2019, the company was forced to rebut claims of high mortality figures with the Impella heart pump, as the numbers seemed to be unsynchronized with clinical data presented for the FDA approval application. These numbers were on the back of studies carried out by the American Heart Association, and were presented at the Association's convention back in November 2019, almost 1-year ago. Naturally, the company responded veraciously, however, investor confidence seemed to dwindle almost immediately, resulting in a run down in share price of around -46% by the end of 2019. This was in spite of the FDA eventually ruling in ABMD's favor in the end. The stock is well off its all time high of ~$458, which was back in September 2018. Thus, longer-term investors have felt a great deal of pain to date. One could identify with the lack of investor confidence back in 2019; with value erosion up until that point, combined with the negative data, this set the trend in place.

Since, the market has regained confidence, and ABMD has reflected this value creation for shareholders, growing both revenues and free cash flow at a CAGR of 29.57% and 48.04% respectively, since 2015. Most recently, gross, FCF and EBITDA margins were 82.99%, 32.18% and 30.07% respectively on TTM figures. Margins are facing some pressure on the back of the coronavirus however, as growth seems to have slowed on the back of the pandemic. Therefore, operating margins may face pressure in our view, which sit currently at around 29%, despite finding some leverage from non-production expenses. Nonetheless, these are impressive growth numbers, and represent management's vision for growth, which is outlined later.

Data Source: Author, ABMD SEC Filings

Data Source: Author

The company has several catalysts on the back of growth in their key markets, alongside additional applications of the Impella pump related to the coronavirus. Back in August, the FDA authorized the Impella pump for indication in left-ventricular unloading and support in patients with COVID-19, especially to those patients undergoing extracorporeal membrane oxygenation, or "ECMO" therapy. ECMO is a procedure where a patient's oxygenated blood is passed outside of their body, to allow their heart to rest. It is commonly indicated for patients with myocarditis, pulmonary edema, and, you guessed it, COVID-19. So the new application for the pump will be a significant driver of sales, whereby units will be administered to a large number of hospitals throughout the US (and potentially abroad), for immediate use in COVID-19 sufferers, whose heart needs some unloading for recovery. This expands on an earlier approval for patients that was authorized back in May, albeit for right-ventricular related symptoms caused from COVID-19, primarily involving embolus. To date, the Impella pump is the only cardiovascular therapeutic instrument that has been approved for use in COVID-19 treatment.

Data Source: Author, ABMD SEC Filings

Consequently, we view this impact as positive on Impella sales, alongside hospital utilization figures. We view the distribution of units to hospitals within the US to increase by 3.57% (adjusted for all products) by next year, the end of the 1st quarter 2021, alongside YoY sales growth of 7.75% from this product alone. Currently, the Impella line originates over 95% of ABMD's total sales, which includes markets in Japan and Germany outside of the US. In light of the new application and growing markets, we believe the company will not be immune to the effects of the markets on surgery utilizations, alongside prescription of device uptake from clinicians, secondary the devastating market effects of the pandemic. We are eagerly awaiting Q3 results to provide guidance for our models, in search for answers of how the company intends to navigate the remainder of FY2020.

What is impressive is the company's demonstrated capacity to generate return over its invested capital. ROIC has consistently remained above 20% for the company over recent periods, alongside high ROA of 20.05% posted in Q2 2020. This is coupled with the company generating ~$0.67 for every dollar invested into the asset base. These are marvelous numbers in our view, and their resilience over time in the midst of market pressures and the pandemic illustrates management's superior vision for generating return over employed capital. We are of the very firm belief that companies who can consistently deliver high ROIC and ROA are ubiquitous with generous valuations, and often trade at a high dislocation from market price, exhibiting many mispricing opportunities. The strength in ROIC and ROA demonstrates to investors the company has the ongoing ability to create value for shareholders, whilst consistently growing top line earnings, alongside free cash available to equity holders. Therefore, we firmly believe that these figures must be priced into a long-term investor's reasoning, in order to grasp the best picture for the company, from an investment perspective. Adding fuel to these points is ROE above 25%, again demonstrating how the company leverages its asset base and capital structure to generate profits.

Data Source: Author's Calculations

On the charts, the market has certainly viewed the stock favorably since the selloff in March. Up until mid-August, there was strong support, with the company rebounding from the support line 6 times to that point. However, by the end of August, the stock had broken support, with a sharp downtick in price, where it has since trended sideways. This was in spite of the stock remaining well away from the RSI 70 line, below overbought territory. Since, it has remained in healthy RSI ranges, but the 10 day moving average has smoothed and possibly shows a level of resistance at around $280+. The overall trend from March until today has been positive, however, and investors are likely to see more upside should the company post a strong earnings, by capitalizing on increased Impella sales volume, alongside extra applications of the device.

Notice on the chart below, the overall trend of ABMD, where the overall support line in red has continued to today, but support was recently breached in August, as seen in the negative deviation below the green support line on the chart.

Data Source: Author's Bloomberg Terminal

Most recently, since August, there has been an all out war between the bulls and bears, where the stock has struggled to find its range. The lower trend line is flat, with a descending upper trend line, gearing up for a descending triangle setup should prices continue south by a few more points. In these situations, empirical evidence shows that in around 60% of cases, the upper trend line may continue along with the direction of the stock. The other situation may be that the stock bounces away from the floor of the lower trend line, and makes a sharp uptick. In light of this, it is difficult to estimate current investor sentiment, however, the overall trend has been bullish from the market since May. Again, a strong Q3 through earnings may be the shorter-term catalyst that long-term investors need for an uptick in price. Impella sales must meet analyst targets at minimum, and positive news about the extensions of the range in the pipeline must show positive early data.

Data Source: Author's Bloomberg Terminal

Positively however, momentum has regained, and we can see a direct correlation in momentum dropping off and the downward movement in stock price for ABMD. This has been observed on several occasions, and for long-term investors is an essential indicator to keep watch over, because it signals potential reallocation points. Where momentum has fallen off, and began to regain in speed, there exists reallocation scale back up towards a previous high. This would allow long-term investors to lower their dollar cost average, alongside recapturing profits after potentially trimming a position that may have entered into their profit-taking zones. We are in favor of reallocating around 0.1-0.5% of a position or of NAV in each of these cases, to reduce risk, and allow greater mobility in refining the hypothesis, whilst also allowing for an easier exit should the stock begin to fall beyond an investor's tolerable level.

Data Source: Author's Bloomberg Terminal

Investors had up until the recent downtick been significantly rewarded with upside for the low level of downside risk at play. We can see on the blue bars on the chart below, the upside volatility shareholders have experienced YTD. Notice however, from August, the level of downside volatility, where shareholders have seen an asymmetric risk/reward profile to the downside. A contrarian viewpoint would view these factors as an exciting point of entry. We are in favor of capitalizing on these opportunities, where an overall trend has been strong, albeit with a recent loss of support, and higher downside volatility, especially close to earnings. Therefore, with the recent downtick, on the back of previous momentum, longer-term investors should keep an eye on the level of downside volatility at play, in order to understand the more medium-term future, for their best investment reasoning.

Therefore, it is difficult to determine the immediate investor sentiment, although the YTD trend has been bullish. In light of Q3 earnings, it will be very interesting to see how the market responds. For now, it may be best for investors to sit on the sidelines, and let the downside volatility and price war level out, until the stock finds new support (or resistance) and then make the most reasoned decision possible. Keep in mind that with the current shape of the yield curve, safety is not providing any near or medium-term gains for investors, so investors with a lower risk appetite should seek quality companies in defensive sectors that are not undergoing any price corrections. For those with a little more tolerance and appetite for risk, ABMD may be a good play, especially with exposure to the COVID-19 domain, albeit without running the race for a vaccine. Other players in the medical devices industry, like Thermo Fisher (TMO) for instance, have profited greatly from this type of model.

Health

On a short-term solvency basis, the company is well capitalized with 5-year asset CAGR of 28.8%. This is alongside no meaningful debt, other than through an $8.4 million capital lease expenditure, and $12.1 million in debt in total. Short-term solvency is well covered ~5x by liquid assets, and the interest expense is covered over 21x. The company has $597 million in cash & equivalents, and enterprise value of $11.96 billion. Asset growth far outweighs liability growth, and the main risks in this regard are in high R&D expenditure requirements to fund ongoing and future pipeline projects. Therefore, there is strength on the balance sheet, and no identifiable drains or pulls on liquidity in the shorter term.

Valuation

We do understand that Q3 earnings are just around the corner, and it will be of value to investors to update our modelling immediately following. Nonetheless, we have provided a snapshot of our DCF modelling on ABMD, which can be observed below. Our implied inputs are related to sustainable growth rate of the company, which we view in line with the high ROE delivered to shareholders over many periods, alongside the increased risk over investing in a risk-free treasury note plus the index, as the hurdle rate.

Base Case:

Data Source: Author's Calculations

In the base case, we see a dislocation in price on today's trading. The value gap is quite large, over 95%. This surprises us, especially in light of the high ROIC and ROA that the company has delivered over recent periods. With further guidance from the company in Q3, these models may show change to the upside.

Upside Case:

Data Source: Author's Calculations

In the upside case, we still see the dislocation in value and market price. We are therefore confident that the company is overvalued with respect to fair value, using our implied inputs. When manipulating the inputs, we can see the effect this has on the valuation, which investors can view below in the sensitivity table.

Data Source: Author

The market has high expectations for performance, with a FWD P/E of 74.25x, and FWD P/Sales of 12.3x. This supports the valuation narrative. Furthermore, the stock trades at 11.39x book value, but in our view, this signals exceptional value creation for shareholders, as we see a P/Book value greater than 3 as exceptional in terms of the value management has created. Furthermore, ABMD has $5.32 in FCF per share, alongside $6.25 CF/Share. Furthermore, the company has a FCF yield of 4.13% and trades at 4.46x FCF currently, with FWD EV/EBITDA of 35.88x. These figures also support the narrative that the stock is currently expensive relative to its underlying value. Therefore, as a value play, ABMD does not fit the bill. It may be better for value players to wait on the sidelines, and keep an eye on the stock price, for any potential pullback towards the valuation we have described, in order to identify an entry point. There are no dividends from the company. Therefore, the realized return is capped at the capital gains from the stock movement. Thus, with the valuation metrics described above, the point must be reinforced that there is a dislocation in market value to intrinsic and relative valuation, which investors must consider in their return prospects.

Catalysts

The potential expansion of the Impella device into the STEMI (heart attack) market is tipped to grow revenues by 25% into 2023 in our base case, should this come to fruition. In the blue-scenario, this jumps to over 30%. With at least 4-5% market penetration, this would certainly play out. The market share could grab up to 30,000 patients in the US alone. The downside is that the rollout of this would take up to 4 years, following completion of ABMD's STEMI-DTU clinical trial. Unfortunately, this trial has been put on hold secondary to the pandemic.

The only real competitor we could identify to compete with Abiomed was Abbott Labs (ABT), however their version of the heart pump is only set for launch by 2023, even later. In fact, Abbott's study has been delayed by a year due to complications within the study design and methodology itself. Therefore, the lack of meaningful competition in the space will allow ABMD to capture more market share, and solidify its positioning as a leading player in the domain. Furthermore, back in May, the company announced that it was launching its expandable sheath platform in 2021. The advantage of this device is that it offers a narrower insertion profile compared to the current Impella device (3mm vs. 5mm) thereby aiming to improve accuracy in placement of the pump and improving outcomes. The company is aiming for its first in-vivo placements outside of the US later this year, but more information is still needed to clarify an official launchpad.

Furthermore, in patients with cardiogenic shock (arising from many causes) there has been a recent downtrend in mortality rates for these patients in the US. We foresee potential Impella adoption within this population subset, particularly as clinicians view the benefits in the COVID-19 application for alleviating cardiac distress. Interesting data has shown that hospitals completing the National Cardiogenic Shock Initiative were able to increase survival rates during cardiac surgery by almost 20% (from ~50%-72%) when the Impella pump was administered before stent procedures, under certain conditions. Therefore, the potential application for indicating the Impella pump range over balloon pumps is high here, meaning that there is a chance the pump may become more integrated with these types of patients into the future, should the procedural guidelines see the value.

Additionally, through recent acquisition activity the company acquired the developer of an ECMO device, Breethe Inc., as a strategic play to benefit their own product line. This is especially true considering the applications of Impella with ECMO therapy, thereby the chance of covarying revenues with these 2 products is high in the current and ongoing environment. And finally, the company remains insulated from disruptor products, especially considering the high switching costs associated with the operating domain, but also due to longer trial times of competitor products and Impella being the only cardiovascular therapy product approved for COVID-19 patients.

Risks

On the charts, the risks are that the company breaks below support at the flat trend line of the descending triangle setup. This would see value erosion for shareholders. Furthermore, this movement may be contingent on Q3 performance, where the company needs to show excellent sales growth from Impella alongside uptake in hospitals across the US. It would be wise to view these 2 numbers in coincidence, because the more units that are distributed, the more potential applications. Furthermore, there are pipeline and execution risks that exist for developments in the Impella range. The company is working on a smaller Impella device, and there has been some controversy surrounding Impella in general, which is associated with an increased risk of bleeding. This could adversely affect prescriber sentiment where clinicians view the safety of the product as inferior to balloon pumps and other types of applications. On these risks, the company has high commitment costs associated with maintaining high levels of R&D to develop ongoing projects. This may impact top-line earnings, coming into the future.

Furthermore, there are industry risks, should COVID-19 persist and hospital utilization remains low. There is conflicting data on this point, however with the gradual reopening of the economy, there may be greater utilization to come with it. Additionally, there are product and sales risks, as the Impella range sits within the cost range of about $24,000+. This is exceptionally high in comparison to other solutions, but the effectiveness is what the company touts as the justification, alongside production costs, one would presume. The price tag may be a deterrent for prescribers in light of the current economic climate, whereby, if patients are presented with the alternative, they may choose that due to price and price alone.

Conclusion

ABMD certainly has the legs to continue its growth story beyond 2020. There are several key drivers of growth from management and these should be priced into the stock over the coming months and into next year. With increased hospital utilization and surgery utilization, the uptake of the Impella heart pump will likely regain double-digit sales growth by the end of 2021. The company isn't immune to the effects of the pandemic in our opinion. However, on the back of solid revenue growth and exceptional return on invested capital, management has demonstrated that they have the propensity to maintain growth in operations and sales for years to come, and reinvest this capital to generate greater returns. We are impressed with these figures, but unimpressed with the valuation. Therefore, as a value play, this may be unsuited for those seeking mispricing and value over the shorter term. For longer-term investors, now may be an exciting entry point for a stock that seems to have a bullish sentiment YTD. Therefore, we would advocate that this stock may be best suited for those with a higher risk appetite and higher risk tolerance. There are options plays that can be utilized as well, with various setups, but we haven't discussed these here. We look forward to Q3 earnings for ABMD for guidance into 2021.

This article was written by

Buy side equity portfolio strategists serving mandates throughout EU/US/APAC. Helping you position your portfolios for the future is our top priority. We offer unique insights via our holding strategies that rest at the long end of the equity curve with minimal drag/drawdown. Shoot us a message to discuss trade ides or talk portfolio construction. Disclaimer:The opinions expressed in all articles do not constitute as investment advice. Please remember to conduct your own due diligence. Hummingbird Investment Group Ltd ("The Company") does not provide investment counsel to non-cliental. Additionally, all investing comes with inherent risks, and there are a plethora risks investors must consider before any investment decision. Past returns are not indicative of future performance, and should not be relied upon as an indicator for investment outcomes. Therefore, the opinions expressed in any and all analyses conducted on Seeking Alpha from The Company, does not constitute as advice, guidance, recommendation or counsel, and therefore should not be received as so. The Company's opinions and commentary are subject to unforeseen market forces which may result in outcomes different from postulates within quantitative modelling. In any case or situation, neither The Company, or its acquired interests, accepts any liability for loss of capital or liquidity erosion, based on an individual's own investment reasoning.

Disclosure: I am/we are long ABMD. 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.

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