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Published: September 15, 2010
A clear trend has emerged in the health care sector. Large
companies are having an awfully hard time finding ways to grow.
As an example, I recently took a look at the dimming outlook for
industry giant Medtronic (NYSE: MDT).
In that column, I added that, "it's been a great era to invest
in smaller medical device companies." These firms (which should
be widened to include the companies in the field of health care
diagnostics) seem better equipped to move nimbly in new markets,
and some have proven to be attractive
buyout candidates. Well, I've been tracking three companies
that I think make great investments -- with or without a buyout.
All three are expected to boost sales around +20% to +30% both
this year and next, and all three are well off of their highs
seen a few years ago.
eResearch Technology (Nasdaq: ERES)
I first took a deep look at this company, which helps test the
cardiac side effects on new, un-tested drugs, back in May after
it had made a smart acquisition in the respiratory monitoring
space.
Shares have been flat since then, but quarterly results have
surely been impressive. The company surged past forecasts in the
June quarter, thanks in part to the newly-acquired respiratory
division. As a result, earnings estimates have been raised for
both 2010 and 2011. Most importantly, I think analysts are still
underestimating all of the benefits of this deal, and I expect
2011 profit forecasts to rise higher in coming months.
The key to that bullish outlook is a swelling
backlog. Both of eResearch's divisions are bringing in new
business at a fast pace, and the company's recent
book-to-bill ratio was 1.5, which means that for every
dollar in sales the company had in the June quarter, it secured
$1.50 in new contracts. Backlog now stands at $300 million,
which implies that the company should have little trouble
matching estimates through 2011. And as new contracts come in,
the 2012 slate is filling up as well.
Demand is so strong because of changes at the Food & Drug
Administration (FDA). An increasing number of drugs have been
rejected for insufficient analysis of side effects, known as
toxicity. By using eResearch's software and hardware in the
testing process, drug companies can provide a much deeper set of
data for regulators to analyze.
I expect shares to move toward the $11 mark during the next
year, which translates into 20 times next year's likely profits.
That represents a solid +40% upside from current levels.
NuVasive (Nasdaq: NUVA)
When a stock on my watch list sells off, I look at the reasons
why. If events have led me to change my long-term view of a
company, then I take it off of my watch list. But if the factors
behind a stock drop are part of my investment thesis, then
shares can be considered even more appealing. That's the story
behind NuVasive, which has lost about a third of its value since
March due to expectations of slowing growth.
On Tuesday, NuVasive cautioned that sales are only likely to
grow +15% to +20% this year, which is in sync with what some
more bearish investors had expected. Even as the company laid
out that new slightly lower growth target, shares barely budged
as investors now view forecasts to be more realistic.
Nuvasive sells a set of products to make back surgery a far less
onerous experience. And the medical community has quickly warmed
to the company's devices. Even as the overall spinal surgery
market has been growing at a slow pace, NuVasive's sales have
risen at least +48% in each of the past eight years.
Nuvasive's gear, which provides surgeons with more than 50 tools
to operate more delicately and quickly, allows doctors to make a
less invasive incision in the side of the body. The company's
visualization systems avoid nerve damage, reduce trauma and cut
operating times by half. In addition, patient recovery times are
faster, hospital stays are shorter and the body suffers less
blood loss and trauma.
As noted earlier, sales growth is starting to cool, but I still
expect NuVasive to grow at a +15% to +20% pace in the coming
years, thanks to a program that continually trains more doctors
on the company's platform. (Only 10% of all back surgeons have
been trained on the platform thus far).
NuVasive recently made a pair of acquisitions to bolster its
position in bone graft regeneration and in the field of cervical
disc replacement. The company is also rolling out new products
targeting specific back ailments like deformity and scoliosis.
Lastly, the company is just getting underway in the untapped
international market. International sales accounted for just 3%
of revenue in 2009, but with new offices opened across Europe,
that figure should rise to 10% to 15% within a few years.
Thanks to this summer's sell-off, shares now trade for less than
20 times next year's profits -- the lowest forward multiple in
the company's history. I think
earnings per share (EPS) can reach $3 by 2013 thanks to
steady sales growth and better leverage off of the company's
fixed
overhead. Shares trade for around 10 times that view. As
investors come to expect moderating growth that can be sustained
in the long-term, shares should re-visit the 52-week high of
$46, which is roughly +50% above current levels.
Luminex (Nasdaq: LMNX)
As is the case with NuVasive, this company has also adjusted to
a world of slower, albeit respectable, growth. Sales rose +40%
in 2007 and 2008, and are now growing closer to +20%. That's
fine with me, especially since there is a clear case to be made
that this level of growth can be sustained for quite some time
to come.
Luminex makes diagnostic tools for genetic analysis, drug
discovery, clinical diagnostics and biomedical research, and
offers exposure to a wide range of medical technology trends.
The strength of Luminex's technology lies in its ability to
rapidly analyze massive amounts of genomic and biologic data.
Previous machines were quite fast, but not fully accurate.
Luminex's xMap system ends that trade-off by offering
highly-accurate and speedy results.
Luminex sells its gear to research labs, which also end up
buying a host of consumables used in the testing process. The
company also sells its software to other industry players, which
incorporate the xMap engine into their hardware. That technology
is protected by more than 50 patents, with an additional 100
patents pending.
Why do I think growth can be sustained? The company has more
than $100 million in cash, which has led to a strong jump in the
development of new products. For example, a 3-D mapping system
has been a recent hit with customers
This is not a cheap stock, trading at nearly 40 times projected
2011 profits. But as sales continue to grow at a steady pace,
profits should grow even faster in subsequent years. The company
has just emerged from a period of heavy investments that will
dampen 2010 profit growth, but set the stage for very robust
profit growth starting next year.
It's hard to place a target price on this kind of
business model, as the real value lies in the core
technology and the ability to grow
market share, and not simply near-term profit trends. As
Luminex continues to grow at a solid pace in coming quarters,
shares should break out of their year-long mid-teens trading
range and move up toward the $20 mark.
Action To Take --> All three
of these stocks make for good portfolio candidates. These
companies are building wide moats around their business by
investing heavily in R&D or growth-inducing acquisitions. They
may no longer be growing at extreme rates, but they appear to be
settling into solid long-term growth in the +15% to +20% range.
Shares may trade erratically, thanks to the occasional quarterly
miss, but should power higher into 2011 -- and beyond.
-- David Sterman
Staff Writer
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