Edwards Lifesciences: Opening My Heart (NYSE:EW)

Late in 2016, I concluded that Edwards Lifesciences (NYSE:EW) was a structural growth play which started to look interesting. At the time the company was deploying a lot of capital on share buybacks and bolt-on deal making, adding to its positioning as a strong growth play in heart diseases.

A Quick Look Back

The passage of time always shows how businesses develop over time and how investment thesis can evolve. Back in 2016, Edwards was a strong player in heart disease, notably with its own valves portfolio, in particular the product SAPIEN 3.

The company generated $2.5 billion in revenues across the board with the sale of heart valve systems and repair products for defective valves, both in surgical and transcatheter therapies. Transcatheter and hearth valve therapies generated $1.2 billion in sales, with spectacular growth rates reported. The surgical heart valve therapy business posted nearly $800 million in sales and critical care revenues just surpassed the half a billion mark.

In 2016, trailing revenues had grown to $2.9 billion, nearly tripling from a billion revenue base a decade before. In the meantime, the company has steadily grown margins to the mid-twenties, as the combination of sales growth and margin expansion, in combination with share buybacks, made that earnings five-folded to $2.50 per share.

At the time, shares traded at $85 per share, yet given that shares split on a three-for-one basis in the summer of 2020, this works down to a current share price of nearly $29 per share. The valuation at the time came in at just over $18 billion, at least that of the equity, or just below that if we factor in net cash. At 28 times earnings and 6 times sales multiple was quite demanding of course, as I concluded to become a buyer around the $75 mark, or $25 at current prices.

We actually saw those levels early in 2015 when shares traded in the low-twenties, as the secular growth continued for years, as did share price appreciation. Shares broke through the $100 mark in the summer of 2021, hit a high at $130 later that year, and by now have fallen to $70 per share. Despite the big pullback, with shares down nearly in half from their peak, they trade at $210 based on the 2014 prices, still marking huge long-term gains of course.

Forwarding To Today

Earlier this year, Edwards posted its 2021 results with revenues up 19% to $5.2 billion, making that revenues essentially doubled between 2016 and 2021. By now the company posts its results across four segments with transcatheter aortic valve replacement revenues posted at $3.4 billion. This was complemented by a +$800 million surgical structural heart and critical care business, as well as a smaller transcatheter mitral and tricuspid therapies segment.

The company has been hugely profitable with GAAP operating profits in excess of $1.6 billion, for margins around 30%, as the company posted GAAP earnings of $2.38 per share, and adjusted earnings at $2.22 per share. Needless to say, with 631 million shares outstanding, valuations were sky-high at a peak of $130, for an $82 billion valuation and sky-high earnings and sales multiple.

Part of the enthusiasm was driven by lower interest rates, as well as a convincing outlook with 2022 sales seen up to $5.5-$6.0 billion and adjusted earnings between $2.50-$2.65 per share, while maintaining a net cash position.

After posting a resilient 10% growth number in the first quarter, the second quarter results revealed some challenges. Second quarter sales were flat on a reported basis, as a strong dollar hid the fact that organic sales were still up 5%, although this pace is much lower as well. The company cut the midpoint of the sales guidance to $5.45 billion following these results, with earnings seen at the lower end of the earnings guidance.

Third quarter sales fell 1 percent to $1.32 billion, yet the continued strengthening of the dollar hurt the business in a greater fashion with organic sales up 7% otherwise. The company cut the full year guidance with earnings now seen between $2.40 and $2.50 per share, a modest cut as shares fell overnight from $85 to $70 per share, cutting the multiple to 28 times earnings here. Despite the continued dollar strength, the company maintained the midpoint of the sales guidance at $5.45 billion.

On a more serious note, the company has seen favorable news on a regulatory front with FDA approval seen for its PASCAL Precision product and SAPIEN 3 Ultra RESILIA valve, giving hope for an acceleration of growth again in the periods to come.

Net cash of around $2.5 billion by year´s end is equal to about $4 per share, as unleveraged assets trade around $66 per share, equivalent to about 27 times earnings. With a current $41 billion enterprise valuation, the company trades around 7.5 times sales, as this has increased a bit from 2016, mostly as operating margins moved up further from the mid-twenties to the 30% mark.

What Now?

Right now, shares are down nearly in half from the peak of last year, as such a move automatically draws my attraction, yet the issue is that valuations were far too demanding from the get go last year. Right now, the current earnings yield of just over 3% looks soft compared to the near-term risk-free rates, yet the long-term positioning of the company remains solid, albeit that organic sales growth has fallen below 10 percent. That being said, some recent FDA clearances might provide a boost to the results, yet that remains to be seen in the coming quarters.

The truth is that the valuations have been de-risked quite a bit here with shares down in at the lowest levels we have seen since 2019 despite the continuation of sales and earnings growth.

While the current valuation remains high, with the earnings yield coming in below interest rates, this remains partially an interest rate bet of course, as is the case of all stocks. As the current earnings yield trails risk-free rates, its growth rates and positioning remains good, driven by a strong track record, larger addressable markets and continued innovation to drive organic growth going forward. This makes that quality and growth will likely prevail over time, as further rate increases in interest rates might hurt the shares in the short- to medium-term.

That being said, Edwards Lifesciences remains top-notch quality in my book, and I am happy to add to my 2015 position on further dips in the sixties here.