Medical Device Daily Senior
The New Year's ball has dropped, signaling the time of year when Wall Street analysts polish up their crystal balls and tell us what they see for the industry in the year ahead. Thursday Joanne Wuensch of BMO Capital Markets (New York) hosted a call to discuss her 176-page 2012 MedTech Outlook report, released Wednesday after the close of markets, which included a number of rating changes.
“We do this report every year, it's sort of our stake in the ground that allows us to take a look at all of the companies that we have under coverage, as well as a fresh look at the industry,“ Wuensch told call participants. “I don't have to tell many of you that medical technology is out of favor – no big surprise there.“
The report includes market share analysis, trends, and updates on all of the companies Wuensch covers in this space.
“One of the most entertaining feedbacks I got when calling around today was 'why do I need to own this group, I'm staying away for now' so that sort of is a sentiment as we enter 2012,“ she said.
As Wuensch pointed out to call participants, the challenges the industry faces going in to 2012 are not new.
“The pressures on med-tech companies are very well known,“ Wuensch said. “I mean, we've been talking for over 18 months now about slower procedure volumes. We've been talking about increasing pricing pressure, economic troubles and persistent high unemployment and how private healthcare insurance is more and more costly. We've been talking about healthcare reform including the med-tech tax in 2013.“
She noted that all of BMO's 2013 estimates include the 2.3% medical device tax and that “the consensus is very mixed out there,“ something investors should keep in mind when comparing BMO's estimates with the consensus.
The sector also faces a number of pressures from Washington as well as pressures in Europe, Wuensch said. “This begs the question, 'what can get the group going in 2012'?“
“The best thing that can happen to this group is an economic recovery,“ she said. “We saw that in the first half of 2011 the stocks really rally as investors began to look toward a second half '11 recover, which clearly never arrived. I think right now the view towards a recovery in 2012 is very muted. I suspect when managements give guidance it will be very conservative. I also suspect that it will be inclusive of without a second half of the year recovery.“
Wuensch said the second thing that would be helpful to this sector is to increase mergers and acquisitions. “Having covered this group for a long time, every year about two to three of my names are taken out, last year none of them were taken out,“ she said.
The year 2011 was marked with fewer deals and those that did happen were done at lower valuations, Wuensch noted. “I think this is sort of an obstacle here as people are thinking that their franchises are worth more than what people are interested in paying for them,“ she said.
According to Wuensch, increased M&A activity would be good not only for the smaller companies but also for consolidation, “shifting pricing power to a market that's increasingly commoditized.“
Another interesting point she made during the call is that slower physician migration to hospitals would be good for the industry as more than 50% of physicians are now working directly for hospitals, bringing about changes in product usage as well as more vacation time for doctors.
And of course, there is perhaps the biggest challenge of all, healthcare reform. “A repeal of ObamaCare would also be nice, we can dream, we doubt it, but we have heard rumor that the med-tech tax may be delayed or consolidated with sort of a corporate tax overall,“ Wuensch said. “Again, we're not holding our breath on that one.“
On the flip side, things that could further hurt the sector include an expanding definition of elective procedures, she noted. “When we started talking about elective procedures they were things like LASIK and gastric bypass procedures – now they're hips and knees ... things that we never thought could be delayed,“ Wuensch said. “Things like physicians taking more vacation time, a deterioration of the economy, more regulation and reimbursement, or more intervention from the FDA.
The BMO report includes several charts that walk through intervention from the FDA and how it has changed from 2006 to 2010, including a statistic that the number of FDA warning letters have increased 150% and the number of Class I product recalls have shot up 555% over that same four-year period.
Another chart in the report looks at average R&D spend on average for our companies they spend 8% of their total revenue on R&D ... where is that money going towards? We're clearly not seeing it on the top line for these companies and we're clearly not seeing it in the innovation that we saw several years ago.“
The BMO report also looks at emerging market opportunities, particularly in China where the market is expected to increase to almost $22 billion in 2016 from $9 billion in 2011, according to the report.
Breaking the industry down a bit by sector, the report does address several trends in cardiology as well as orthopedic.
“In the land of cardiology, we suspect that the (implantable cardiac device) market is going to continue to be difficult, particularly in the first half of year,“ Wuensch said. “But then as we get into the middle of the year and the second half we are facing easier comps in the United States.“
In orthopedics, “volumes remain soft, hip sales are relatively sluggish and knee procedures are flat,“ she said.
The BMO report also includes a number of rating changes, which Wuensch addressed during the call. Among them is ArthroCare (Austin, Texas), which BMO upgraded to outperform from market perform. “The company has been meaningfully expanding operating margins, we expect it to go up to 22% in 2012 from 21% in 2011 ... it works on a takeout, it works on a sentimental basis, so we're upgrading it,“ Wuensch said.
Interestingly, ArthroCare also was identified recently by Canaccord Genuity (Toronto) analyst William Plovanic as a value play (Medical Device Daily, Dec. 27, 2011). For ArthroCare, Plovanic noted in a recent report strong strategic asset with about 50% share of the energy market in sports medicine and about 40% of the tonsillectomy market as well as a strong positive cash flow and high free cash flow.
On the downgrade side, Wuensch said Volcano (San Diego) was the most difficult name she had to downgrade of the group. She noted a difficult PCI market, as well as the company's large OUS business and the fact that the company's stock is not cheap. “It's an expensive stock with a questionable top line and an over-optimistic bottom line on the street numbers, so I'm just simply stepping aside for right now,“ she told call participants. “Again, this is the hardest one to downgrade of the group because I do like it long-term.“
Published: January 6, 2012