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For as many execution issues as Boston Scientific (NYSE: BSX ) has had over the years, current management deserves credit for the extent to which they have changed both the reality of the business and Wall Street's perception of it. The company is still behind large rivals in key growth areas like transcathether heart valves and renal denervation, but it is no longer a notable laggard in terms of reported growth.
The only real downside that I see to the story is that expectations have moved to a point where it seems like the Street is giving the company a lot of benefit of the doubt with respect to its execution in 2014. The next 12 months should see meaningful progress across multiple product lines, but it's hard to argue that the shares are notably undervalued after the big move over the past year.
Third-quarter results largely on target
Boston Scientific didn't have the cleanest quarter, but everything largely netted out to an in-line performance. Importantly, the company's 4% organic growth was superior to that of St. Jude Medical (NYSE: STJ ) , on par with Abbott Labs' device business, and generally respectable in the larger context of med-tech stocks this quarter.
Boston Scientific's CRM business was up 1% (constant currency) as ICD performance offset pacemakers. It looks like BSX picked up a little share from St. Jude Medical this quarter (mostly in pacing), but Medtronic (NYSE: MDT ) is all but certain to emerge from this quarter as the leader in the space with roughly 50% share.
Although drug-eluting stent revenue declined about 6%, interventional cardiology revenue was down 2% and cardiovascular revenue was up 1% on strong peripheral performance (up 7%). MedSurg was surprisingly strong (up 12%), as excellent performance in neuromodulation (up 32% versus just 3% for St. Jude) and high single-digit growth in both endoscopy and urology/gynocology all helped.
Margins were mixed. Boston Scientific has made good progress with its gross margins, as this quarter saw an improvement of more two points to more than 70%. SG&A spending was up by a low double-digit percentage, though, and adjusted operating income declined a bit from last year.
Execution still the big question
Boston Scientific has made a lot of progress in fixing the assorted problems and inefficiencies that weighed on results for a number of years. Now-former CFO Jeff Capello played a big role in the company's restructurings and its turnaround so far, and his loss (he is resigning to pursue a CEO role or a role within another company that would lead to a CEO position) will be felt.
On the other hand, Capello leaves Boston Scientific with several interesting developments on the way. While I do believe that Boston Scientific, Abbott, and Medtronic are all going to struggle to show significant long-term growth in stents, it's a profitable business, and Boston Scientific's new Synergy platform should drive a rebound in sales, though fierce competition from Abbott and Medtronic will likely keep that rebound from turning into market dominance.
Elsewhere, I think 2014 can be a big year for the company's S-ICD product (particularly given that supply issues seem to be over), the Lotus transcatheter valve, the Vessix renal denervation device, and the company's Watchman left atrial appendage closure device. Boston Scientific is well behind Medtronic and Edwards Lifesciences in transcatheter valves and Medtonric and St. Jude in denervation, but I think the markets are large enough to make a third or fourth place position worthwhile, and superior data (which I'm not expecting, but not refusing to consider) could offer some upside. It's important to note, though, that the Lotus valve and Vessix device will not be available in the U.S. in 2014; rather the news will be driven by introductions in Europe and progress in clinical trials.
The bottom line
With Boston Scientific's share price up more than 100% in the past year, I think it's impossible to argue that the Street hasn't noticed the improvements at the company. To that end, even 4% long-term revenue growth and 8% free cash flow growth will only get you to "fairly valued" today. Granted, fairly valued still means the potential for high single-digit year-to-year appreciation, but I believe the risk-reward balance on these shares is starting to skew away from value investors' favor.
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