Ask almost anyone about tech companies, and you’ll likely hear about Apple, Google, and of course, Microsoft. But, tech goes far beyond the newest iPhone and whatever version of Windows next needs to be fixed.
In fact, smartphones pale into insignificance when we talk about technology’s role in medicine. Not only do we get literally life saving technologies, but we also get greater productivity and lower costs. With lower costs, we’re able to extend the reach, financially and logistically, to more and more people who need it. The widening reach at lower cost means patients return to work sooner, meaning the economy gets a boost. Technology in medicine is technology that really matters.
One of the sectors driving medical technology forward is Medical Devices; companies large and small competing to improve patient care and to reduce health care cost. At the same time, some also reward investors.
Among those companies is Edwards Lifesciences Corporation (EW, Financial), a California-based developer of artificial heart valves and more. Now doing business in some 100 countries, it focuses on surgical and nonsurgical heart repairs, as well as monitoring the health of patients undergoing heart surgery or heart patients in critical care.
Edwards came to our attention by way of the Undervalued Predictable screener at GuruFocus. Making through this screener means the company has shown consistent earnings and is valued at or below its intrinsic value.
Before we get to the specifics, though, let’s work through a profile of the company.
History
1958: Miles "Lowell" Edwards, a 60-year-old, recently retired engineer, sets out to build the first artificial heart (motivated in part by two bouts of rheumatic fever as a teen); a specialist in hydraulics and fuel pumps, Edwards took his idea to Dr. Albert Starr; the doctor recommends Edwards focus instead on artificial heart valves; together they begin designing, developing, and testing a mitral valve
1960: heart surgery takes a leap forward when the first Starr-Edwards mitral valve is successfully placed in a patient;
1961: Edwards Laboratories formed as a result of this success
1963: Development of the Fogarty embolectomy catheter spawns Edwards’ Vascular business
1966: Edwards Laboratories bought by American Hospital Supply Corporation
1971: Development of the Swan-Ganz catheter leads to Edwards’ Critical Care business
1985: Baxter International buys Edwards Laboratories
2000: The company is spun out of Baxter as Edwards Lifesciences; begins trading publicly on the New York Stock Exchange (symbol EW)
EW’s business
In its online Investor Presentation, Edwards calls itself, "...the global leader in the science of heart valves and hemodynamic monitoring...." The latter refers to systems which monitor a patient’s heart while under surgery or in critical care. In turn, this allows surgical staff and doctors to balance the oxygen supply of patients during critical periods, and improve the patient’s chances of survival.
Within that context, we can look at its three main product lines:
- Surgical Heart Valve Therapy (SHVT): As the company’s history suggests, the company produces artificial heart valves and products for repairing heart valves. The products are made from "biologically inert" animal tissue and wireform stents.
- Transcatheter Heart Valves (THV): While SHVT products are surgically implanted, these products are put in with catethers, for nonsurgical placement. The company says it leveraged its knowledge and experience in surgical heart valve therapies to develop THV replacement technology.
- Critical Care: This line of business refers to those hemodynamic monitoring systems, which allow the monitoring of patient oxygen during surgery or while in critical care.
This chart shows EW’s revenues by product line during the most recently reported quarter:
As we can see, Critical Care accounts for a quarter of revenue while the other two lines split the remainder, about evenly.
Edwards Lifesciences sells its products in 100 countries. This chart shows the origin of Q2, 2014 revenues by geographic regions:
Roughly three-quarters of its sales come from two regions: the United States and Europe.
Competition
While the company describes itself as a world leader, it nevertheless faces competitive pressures. Both large and small firms make up the competitive landscape, all aiming at newer and better products through technological innovation.
Edwards describes that environment this way, in its 10-K for 2013, "We believe that we compete primarily on the basis of clinical superiority and innovative features that enhance patient benefit, product reliability, performance, customer and sales support, and cost-effectiveness."
Major competitors include St. Jude Medical, Inc. (STJ, Financial), Medtronic, Inc. (MDT, Financial), Sorin Group (SRN, Financial), ICU Medical, Inc. (ICUI, Financial), PULSION Medical Systems AG (PUS, Financial) and LiDCO Group PLC (LID, Financial).
To market its products, the company uses both a direct sales force and independent distributors. They work directly with physicians and other clinical staff, hospital management, ministries of health, and others. Marketing also includes education and training initiatives.
It reports having a diverse customer base, with no single customer making up more than 10% of total sales.
Growth strategy
Given the nature of the business, it’s no surprise the growth strategy depends heavily on technological innovation and product development. That direction gets reiterated in the 2013 Annual Report, "...we will remain focused on developing and investing in technologies to better address patient needs, including minimally invasive technologies, with the potential to improve patient care by enabling faster, more reliable procedures, shorter hospital stays, reduced complications and improved survival."
Looking within that statement, we note the pressure to reduce the costs of health care.
Edwards also looks to acquisitions to maintain its growth profile; in 2012, for example, it spent some $42-million to buy BMEYE, a medical device company that specializes in advanced hemodynamic monitoring (Clinical Care).
The following chart shows growth of EBITDA since the year 2000:
Takeaways: Within its focused field (heart-related), Edwards enjoys diversified product lines and geographic markets. It depends on research and development to stay competitive with major and minor players in the medical devices field. In addition, it has made acquisitions to continue growing its revenue and EBITDA.
Management
Chairman and Chief Executive Officer: Michael A. Mussallem has held these positions since 2000; he has a degree in chemical engineering and served in senior positions at Baxter International before joining EW.
Corporate Vice President and Chief Financial Officer: Scott B. Ullem took over the position in January 2014 after holding a similar position at the Bemis Company; prior to that he had worked in investment banking.
Corporate Vice President, Advanced Technology and Chief Scientific Officer: Stanton J. Rowe joined Edwards in 2004 after it bought Percutaneous Valve Technologies, a company he helped to found in 1999 and of which he served as president and CEO.
All together, Edwards has a senior management team of 14: CEO Mussallem and 13 corporate vice presidents.
Board of Directors: A board comprised of Chairman/CEO Mussallem and seven directors. Members of the Board have expertise or experience in health care, health care policy, technology, energy, venture capital, accounting, pharma, academia and insurance.
ISS Governance QuickScore Summary: Edwards receives 9/10, a poor score, with 1/10 indicating a lower governance risk and 10/10 representing higher governance risk. It receives five red flags, for Board Practices, Voting Formalities, Pay for Performance, Termination, and Controversies. It receives one green flag, for Equity Risk Mitigation.
Takeaways: Longevity in the top positions tells us the executives have done a good job, and the board appears to have a good range of experience/expertise in the requisite areas. We also note, though, that this is a big management team, and that ISS (Institutional Shareholder Services) has concerns about board practices.
Ownership
Gurus: Nine different gurus followed by GuruFocus own shares of EW. Largest among them is the Vanguard Health Care Fund (Trades, Portfolio) with 4,920,000 shares; Ron Baron (Trades, Portfolio) holds the second-largest number, at just over one million.
Institutions: Some 93% of EW shares belong to institutional investors (including those noted above), and with the exception of one blip, has stayed near this level over the past five years:
Shorts: Currently 3.3%, but has been over 10% (briefly) a couple of times in recent years:
To put that increased short interest into context, take a look at the stock price between October 2012 and January 2014, and then after January 2014 when Edwards won a major patent infringement lawsuit against Medtronic, Inc.:
Insiders: Consistently 1% for several years, which may be the result of management and directors consistently selling their stock options as they receive them. For example, once a month, Chairman and CEO Mussallem sells 29,500 shares; his current holding still totals a hefty 293,350 shares, so we will assume he is diversifying his portfolio as he earns his options.
Takeaways: We won’t get into the details or the merits of the legal battles between Edwards and its competitors, but will bear in mind that the fate of technology-driven companies may be settled in courtrooms, as well as the lab. Otherwise, insider interest is consistent, and both gurus and institutional investors seem to have faith in the company’s long-term future.
EW by the Numbers
Financial Strength
Edwards Lifesciences earns a 9/10 for Financial Strength and 8/10 for Profitability & Growth at GuruFocus:
The green icon for Cash to Debt indicates the company beats its peers on this metric, while the red indicates it has done better during its own history. We’ll take the latter with a grain of salt: when the ratio is greater than 1 it indicates the company could pay off its debts with cash on hand; at 2.48 it means debt is a fraction of cash on hand. And, according to GuruFocus its ratio of 2.48 beats 72% of its 393 peers in the Medical Devices industry.
We can also see Edwards free cashflow has grown consistently since the end of the financial crisis:
Takeaways: A strong financial position means Edwards Lifesciences should be able to continue growing its business through organic growth and acquisitions, while at the same time rewarding shareholders with share buybacks.
Valuations
EW has earned a place on the Undervalued Predictable list at GuruFocus. The predictability part refers to its ability to consistently increase its earnings, and more importantly gives investors an indication of what they can expect in the future (generally, higher predictability = higher returns).
With a predictability rating of 4.5 stars out of five, Edwards is at the high end of the range. Backtesting by GuruFocus found that stocks with this rating average a gain of 10.6% a year over 10 years. As the following image shows, the Top 25 Undervalued Predictable companies outperformed the S&P 500 by more than 24% since 2009:
Turning to the Undervalued half of the screener, we see the Discount Cash Flow value of the company at $180.00, which is 42% below its recent value of $104.28.
And the screener puts the intrinsic value of Edwards at $200, 48% below its recent value. GuruFocus explains the valuation this way, "We applied the discounted cash flow and discounted earnings to the top ranked predictable companies, and calculated the intrinsic values of the these companies. These are the companies that appeared to be undervalued as measured by discounted cash flow model or discounted earning model."
Takeaways: Edwards Lifescience brings a strong pedigree to the market, with a highly predictable earnings history and valuations well below its current price.
Opportunities and risks
- As with other companies in the health care sector, EW can expect to benefit from an aging population with increasing medical needs.
- Stakeholders from policymakers to insurance companies are depending on innovation and technology to reduce health care procedural costs, even as demands keep rising.
- EW owns more than 2,500 patents.
- EW was able to invest 16% of 2013 sales in research and development.
- EW has the capability of selling successfully developed products in about 100 countries (however, this may involve repeated regulatory applications and testing).
- Risks include the flip side of several of the opportunities above, including intense competition in its market space and the risk its products become obsolete or underperformers.
- Being in the medical space also means exposure to litigation, including patient lawsuits and court challenges from competitors.
- With international sales comes exposure to currency risks and the cost of managing complex currency relationships.
- Political and economic risks include changes in health care funding and regulations, interest rates, and the general economic climate.
- Even "mad cow disease" poses a risk to Edwards, since (inert) bovine tissue is used to manufacture pericardial tissue valves.
For more on these and other risks and opportunities, see the Edwards Lifesciences’ Annual Report and 10-K Reports.
Outlook
Edwards seems well positioned to move ahead. Opportunities appear to outweigh the risks, and the company has managed itself well in the past. At the same time, we can’t help but wonder what might have happened to the share price had the court battle with Medtronic Inc. (as noted above) gone the other way.
Conclusions
Its path forward may present bumps, but Edwards Lifesciences offers potential value for investors who want capital appreciation. Since it does not pay a dividend, EW will not be suitable for income investors.
The Undervalued Predictable screener lets us know this stock has generated consistent and growing earnings in the past, and that it currently trades below its intrinsic value. All things being equal (and of course they aren’t always), growing earnings should pull up the stock price over time.
It appears Edwards Lifesciences has all it needs to continue that growth, which makes it a candidate for the short lists of long-term investors.
