(Seekingalpha.com)–About 15 years ago, NuVasive developed what it claims to be a revolutionary XLIF spine surgery method. The minimally invasive procedure is welcomed by all stakeholders, with much less impact for patients and resulting in real costs savings.
Following this invention, NuVasive has steadily grown to become a business with over a billion in sales, operating in a global market worth roughly $10 billion, with minimally invasive procedures rapidly growing within the spine market of course.
Despite this steady growth of sales, actual margins results on the bottom line are not that impressive, even as the company has made progress on this front over the past decade. GAAP operating margins have risen towards 10% of sales, as adjusted margins were a bit higher at 16.6% in 2017; yet this excludes many real costs to the business. Furthermore, margins come in far below the 25% long-term target, which are margins more in line with the rest of the medical device industry.
Disappointments in terms of earnings and not necessarily sales have turned shares of NuVasive into a long-term roller coaster. Following enthusiasm on the solution, which pushed shares up to $50 in 2008, shares fell to just $10 in 2011 as growing sales were not resulting in operating leverage. Ever since, shares had rallied to $80 in 2017 again, before now losing nearly half of their value again at $45 per share.
Developments Ever Since
In February of last year, NuVasive reported 2017 results which showed that sales came in at $1.03 billion that year, following a modest 7% increase in sales while fourth-quarter sales were flat. The company did anticipate modest growth in sales in 2018, but the $1.10 billion sales guidance (plus or minus $5 million) was not that impressive.
The good thing is that earnings quality was going up. NuVasive reported adjusted earnings of $1.91 per share in 2017 and GAAP earnings of $1.50 per share. Excluded in the earnings number are various tax effects, amortisation charges and non-cash interest accruals on convertible loans. In actual margin terms, NuVasive reported adjusted operating margins of 16.6% and GAAP margins of 11.0%.
For 2018, the company was anticipating some margin progress to be seen hand-in-hand with modest sales growth. Adjusted operating margins were expected to rise a percent to 17.6% of sales as GAAP margins could improve 2% points to 13%. Based on these expectations, NuVasive predicted that adjusted earnings could hit $2.44-2.47 per share in 2018, and GAAP earnings at $1.56-1.59 per share, that is at the start of 2018.
Shares have seen momentum even as the company cut the full-year GAAP guidance alongside the first-quarter earnings report, while keeping all else constant, due to a large litigation liability. Second-quarter sales, as reported on the final day of July, were particularly solid, with revenue growth accelerating to 8.5%. Nonetheless, the company cut the full-year adjusted earnings guidance to $2.37-2.40 per share, with GAAP earnings now seen at just $0.45-0.48 per share, creating similar conditions as seen in recent years.
Late October, third-quarter results showed another resilient quarter, as shares had fallen back from a high of $70 this summer to $55 at the time. This was despite the solid 9.8% increase in reported revenues. The solid sales momentum prompted the company into raising the full year sales guidance by $7.5 million to a midpoint of $1.1075 billion. Problematic is that margins continue to lag with adjusted earnings seen now at $2.13-2.23 per share, while GAAP earnings are now seen at just $0.22-0.31 per share.
The discrepancy between both earnings metrics now runs at nearly $2 per share and has grown in every of the past few quarters. While amortisation on intangibles amounts to nearly a dollar on a pre-tax basis, other costs of roughly $1.20 per share on a pre-tax basis involve real costs such as restructuring, poor investments, consulting fees, litigation and non-cash interest on convertible bonds. Adding back $1 per share on a pre-tax basis to adjust for the amortisation expense makes that I see earnings power as just at around a dollar, or a little more.
With a share count of roughly 52 million shares, NuVasive has a market valuation of $2.3 billion at $45 per share. The business holds just $75 million in cash yet operates with a net debt load of $528 million, mostly from convertible debt. That makes for a $2.8 billion enterprise valuation.
Based on that valuation and a $1.1 billion sales number, the business is valued at just 2.5 times sales. This comes as established medtech players often trade at 4-5 times sales while showing slower growth. The “discount” mostly stems from the relatively modest non-GAAP earnings power of the business, let alone GAAP earnings power.
Reality is that margins simply remain lacklustre. If the company could really deliver on 25% adjusted margins and a clean EBIT margin number around 20%, I peg EBIT at $220 million. Including $20 million interest and a 20% tax rate, I see earnings at $160 million in that case, as $3 per share in clear earnings power would result in compelling upside from current levels.
Reality is that this year is not seen in isolation, as NuVasive has seen similar margin struggles for a long term, although recent sales momentum is quite encouraging. For now, the reality is that earnings multiples come in at 20 times based on adjusted earnings, but those earnings are quite adjusted with many adjustments showing up from time to time. This and a 2 times leverage ratio based on a very adjusted EBITDA metrics make that I would be cautious as well, despite the optical low sales multiple.