magicmine
Valuation alone doesn’t move stocks – expensive stocks don’t fall just because they’re expensive, and cheap stocks don’t rise just because investors suddenly decide they’re too cheap. In most cases, it requires some sort of driver or catalyst to get investors to reconsider a name, and that’s a challenge for NuVasive (NASDAQ:NUVA) today.
The shares of this spine-focused medical device company do look undervalued today, but they’ve looked undervalued for a while. Although the shares have slightly outperformed the broader medical device space since my last update and outperformed names like Alphatec (ATEC) and SeaSpine (SPNE) while recently starting to lag Globus (GMED), they still haven’t done anything to celebrate over the last five years.
NuVasive is salvageable, but the company’s management needs to offer more than what is apparent today – investors need to have a reason to believe in growth drivers beyond the cervical portfolio and that long-awaited margin improvement will actually materialize. While this could happen, there’s a real risk that “okay, but not great” growth and margins keep a lid on the share price performance at NuVasive.
Second Quarter Results – A Little Better On The Topline, But Not Really Great Overall
NuVasive’s second quarter was, at best, “mixed” and not really the sort of quarter that’s going to shift sentiment in a meaningfully positive way.
Revenue rose 8% and beat expectations by close to 2%. U.S. spine (“Hardware”) revenue rose 3% on improved case volumes, and that was better than the declines at Johnson & Johnson (JNJ) and Stryker (SYK) and on pace with Globus, but with the cervical portfolio growing more than 20%, there’s still weakness in the core portfolio.
U.S. Surgical revenue rose 6%, with improved Pulse sales offsetting a year-over-year decline in biologics, while international sales rose more than 20% in constant currency.
Gross margin declined 120bp to 72.4%, missing by 80bp, and the med-tech sector is still seeing noticeable negative impacts from supply chain issues (components, shipping, et al.). Operating income declined 1%, missing by 3%, and operating margin fell 80bp to 13.1%, missing by more than 30bp.
Management basically held the line on guidance, though hitting the full year target of 9% to 11% constant currency growth is going to require acceleration from here. Ongoing post-pandemic normalization and some new product introductions can support that acceleration, but the overall U.S. spine market isn’t looking especially robust right now.
Waiting For Something To Disrupt The Business (In A Good Way)
It’s been a long, frustrating wait for real momentum in NuVasive’s business, and it does explain, at least in part, why these shares have been a laggard over the longer term (five-year, 10-year, and 15-year comparisons to the sector).
Revenue growth over the last 15 years hasn’t been bad (around 15% a year), but that growth has slowed considerably in the last five years (to the low single digits). Salesforce defections have been a recurrent problem over the years, and relative to companies like Globus, I think you can argue that NuVasive has under-innovated, and that’s taking a toll on core franchises like the lateral interbody fusion business. The company was also certainly slow to recognize the importance of robotics, and with the Pulse robotic system no longer expected to achieve first-in-human use this year, that timeline is slipping further.
NuVasive has also struggled to hit even its revised operating margin targets. Where the company once talked about the possibility of 25% or better operating margins (some rivals have achieved high-20%s for margins), more recently the goal has been on the order of 20%, but the company is still well short of that – operating margin was just over 13% in the second quarter, and the most bullish sell-side projections I’ve seen don’t call for 20% margins at any point over the next five years.
On the positive side, the company’s cervical disc business is growing well, and I still see strong growth potential here, as NuVasive’s discs are the only ones clinically proven to produce better outcomes than fusion surgery. I also believe the full Pulse platform (not just the robotic aspect, but the planning, neuromonitoring, imaging, and navigation capabilities) can be a significant growth driver, with an addressable market opportunity of around $1.5B (against expected total revenue of around $1.2B in FY’22).
Still, the numbers are what they are, and what they have been for several years now, and it hasn’t been enough to support a sustained rerating for the shares. An upcoming Analyst Day in October could be a chance to re-energize the Street and drive a second look at the shares, but I think there is still a meaningful credibility gap here and even if management were to issue bold growth/margin forecasts, there will still be a “show me” aspect to this story.
The Outlook
While NuVasive’s operational performance and outlook really aren’t that bad, the reality is that it leaves the company in a sort of “twilight zone” for med-tech. By and large, medical device investors want 15%-plus revenue growth (in excess of 20%, ideally) or excellent margins with consistent above-average growth (a company like Stryker). Unfortunately, the mid-single-digit revenue growth and gradual EBITDA margin improvement through the mid-20%s that I expect from NuVasive really isn’t enough to fit either profile.
I do expect around 7% annualized revenue growth for the next three years from NuVasive, and I do see some product opportunities like Reline (posterior cervical fixation) and Modulus ALIF (3D-printed implants for lateral fixation) that could outperform. I’m likewise still a believer in the cervical disc and Pulse franchises, though the delays with the robot functionality are disappointing. As far as margins go, this is the real “show me story” for me; I can see areas for improvement, but whether the company can deliver is the big question.
Discounted cash flow (a long-term revenue growth rate of 5% and an FCF growth rate of 15%) suggests a nearly double-digit long-term annualized prospective return, while a growth/margin-driven EV/revenue approach suggests a fair value in the mid-$60s.
The Bottom Line
This is certainly a less positive tone on NuVasive than I’ve taken in other articles, but the reality is that while I like the company and still think the shares are undervalued, it’s tough to see why institutional investors will turn to this name with any urgency or enthusiasm. Again, there are some potential catalysts out there, but I think the company has to show evidence that they can and will deliver on them before the stock will move.
I do see worthwhile upside here, but investors considering the name must have above-average conviction that management can drive better growth and/or a willingness to accept the risk of these shares continuing to lag, given a lack of appeal to speculative growth or quality growth investors.
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