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A solid piece of real estate investing advice holds that you should be wary of buying a good property in a bad neighborhood. Along similar lines, I recall studies that have indicated that 70% to 80% of a stock's move can be attributed to the performance of the sector to which it belongs. That's all relevant to Boston Scientific Corporation (NYSE:BSX) today, as, although this large-cap med-tech continues to perform well and offers what I believe to be differentiated growth drivers, the med-tech sector has not been performing well of late.
I continue to believe that Boston Scientific can generate high single-digit long-term revenue growth on the back of opportunities like pulsed field ablation, the Watchman left atrial appendage closure device, heart valves, peripheral intervention, endoscopy, prostate health, pain, and endoscopy. How the market will value that growth is a bigger unknown; if the sector is retreating back to historical valuation norms, there's still upside here, but perhaps not enough to appeal to some investors.
A Strong, But Not Exactly Surprising, Third Quarter
Boston Scientific delivered a lot in its third quarter report. However, a lot was expected by the Street, and the net outperformance was relatively modest - about $0.01/share of operating outperformance sweetened by a $0.01/share lift from a lower tax rate. Management did raise guidance for Q4'23, though here again expectations were already robust.
Revenue rose about 10% in organic terms, which was good for an almost 2% beat versus the average sell-side estimate. Only a few lines missed revenue expectations, with Interventional Cardiology Therapies (or ICT) up 7.2%, but a little shy of expectations and Neuromodulation up about 3%, but also a little below expectations. Watchman, too, could arguably be called a minor disappointment, with 23% revenue growth that was "only" in line with expectations.
As far as positives go, Cardiac Rhythm Management (or CRM) was up 5% and 2% ahead of expectations, while Electrophysiology was up 27% and 4% ahead of expectations. Peripheral Interventions rose more than 8%, beating by more than 3%, while Endoscopy (up almost 11%) and Urology (up 11%) were 2%-3% ahead of expectations.
Gross margin declined by 50bp year over year to 70.2%, missing by 160bp on forex. Operating earnings rose 17% (including amortization), with margin up 100bp to 20.2%, while ex-amortization operating income rose more than 13%, with margin up 50bp to 26.1%.
Adding More To The Growth Arsenal
Between a recent trial read-out and another M&A transaction, Boston Scientific continues to add more drivers to its long-term growth story.
The recent TCT meeting saw the read-out of IDE trial data for the company's Agent drug-coated balloon for the treatment of in-stent restenosis. In-stent restenosis is a fairly common occurrence and one that the medical community has been trying to address for over two decades, with very mixed results - even now, about 10% of all percutaneous coronary interventions are to treat in-stent restenosis (typically with balloon angioplasty or another stent, though sometimes other approaches like mechanical or laser atherectomy).
In this study, a study that included a high rate of patients with multiple "stent sandwiches" (stents placed within stents to treat prior in-stent restenosis), the Agent balloon showed a target lesion failure rate of 17.9% at one-year follow-up versus 28.7% for angioplasty, with improvements in metrics like heart attack. Target lesion revascularization was also better, 12.4% versus 24%, though I know some bulls were hoping for a <10% result in the Agent group.
I think the Agent DCB represents a roughly $500M market opportunity today, with upside to that number over time. Although drug-coated balloons are used reasonably often in Europe (for nearly a decade), the approach hasn't had similar success or adoption in the U.S. Agent already has a breakthrough device designation, and given the incidence of in-stent restenosis, this should be a solid opportunity for Boston Scientific.
Another growth opportunity was added via M&A in September with the $850M acquisition (excluding unspecified contingent payments) of Relievant Medsystems. Relievant has developed the Intracept intraosseous nerve ablation system for the treatment of chronic lower back pain (through the ablation of the basivertebral nerve), and the system is already FDA-approved and reimbursed by Medicare.
The procedure is relatively straightforward - a 30-minute procedure performed under general anesthesia - and can be done in an ambulatory care setting. While Medicare reimbursement is pretty good ($13K for in-hospital and $9K for ambulatory), commercial insurance coverage is still relatively low. Boston Scientific has plenty of experience working with insurers on new treatments, though, and with an addressable market of around $2.5B (5.3M people with clear vertebrogenic pain), this looks like a credible addition to the neuromodulation portfolio.
Although not new, Boston Scientific did also highlight some arguably underappreciated potential growth drivers during its September analyst day that are worth mentioning here. TheraSphere, a radioembolization therapy, is currently used almost solely in unresectable liver cancer, but the company intends to pursue opportunities in brain cancer (GBM, in particular) and prostate cancer. Also in oncology, management is looking to grow the SpaceOAR business as more intense stereotactic body radiation therapy (or SBRT) becomes more commonplace in prostate cancer.
Last and by no means least, management highlighted renal denervation, mitral and tricuspid valve repair/replacement, and intravascular lithotripsy (Shockwave Medical's (SWAV) core market) as key growth markets of interest.
The Outlook
The worst I can say about that September Investor Day is that it didn't offer a lot that was new or thesis-changing to me. The Street liked the reassurance on growth (an 8% to 10% growth rate range versus the 7% to 9% expected going in), margins (up 150bp through 2026), and free cash flow (improving conversion to 70%), but I had already expected a lot of this. Even so, it was a good opportunity to highlight growth drivers like Watchman (potentially a $6B market in 2030), transcatheter valve repair, and venous thrombectomy, as well as broader opportunities like neuromodulation, endoscopy, and urology that are expected to grow around 7% a year.
The changes to my model at this point are basically just fine-tuning, and I'm still looking for a long-term revenue growth rate above 8% (and over 9% across the next three years). Pulsed field ablation therapy alone should drive a meaningful portion of this growth (around a third to half), with other contributors like Watchman, TAVR, and so on still significant.
I'm still looking for high-teens free cash flow margins over the next five years and low-20%s beyond that, supporting double-digit FCF growth. I'm also expecting an EBITDA margin of around 30% next year.
Boston Scientific shares aren't that cheap on a discounted cash flow basis, and I'm not surprised at all by that (large-cap med-tech growth rarely looks significantly undervalued on that approach).
Whether the shares are cheap on a growth-based EV/revenue basis is a trickier question. Over the last several years, med-tech valuations meaningfully expanded and particularly for larger companies able to consistently deliver above-average growth. More recently, though, the entire sector has sold off fairly significantly.
Using the more recent norms, Boston Scientific could support a 6.7x forward multiple. If the market is in fact going back down toward longer-term norms, then the multiple falls to something more on the order of 5.7x. At the most conservative derating, the multiple would drop all the way to 4.6x. That's a difference between a $63.50 par value at the high end, $53 in the middle, and about $42 at the low end.
The Bottom Line
Wherever med-tech valuation norms settle out, I don't have any real worries that Boston Scientific will deliver above-average growth and get a multiple premium for that. I see the $42 scenario as relatively unlikely, and while a fair value in the $50s may not be enough for some readers, I think, on balance, Boston Scientific is still a stock worth owning.
