Are Boston Scientific Corporation's Little Misses Pilling Up?

Never estimate how often sell-side analysts or institutional investors can shrug off disappointments from stocks they want to like, but it looks like Boston Scientific (NYSE: BSX  ) is starting to chew up some of the goodwill on the Street. Boston Scientific isn't performing poorly per se, but the company continues to report slightly disappointing quarters that run counter to the idea that it has truly turned a corner in its operating history. Boston Scientific shares don't look expensive in a world lacking cheap med-tech names, but it's worth remembering that the Street is already banking on some pretty aggressive margin improvements and sales growth driven by devices yet to even secure approval.

A slightly spotty first quarter
Boston Scientific didn't have a bad first quarter, so much as it didn't have a quarter that was strong enough to live up to the rising expectations for this company.

Revenue rose 1% as reported and 3% on an organic basis, which was slightly below expectation. The company's cardiac rhythm management (or CRM) business was a notable laggard, falling 2% and missing the sell-side target by about 4%. ICDs were particularly weak, down 3%, as St. Jude Medical (NYSE: STJ  ) continues to gain share (ICD sales up 3%).

Margins and profits were a little soft relative to expectation. Gross margin improved 160bp from the year-ago period, but was just a bit lower than expected. Operating income rose 18% on an adjusted basis and came in almost in-line with expectation, but that seemed to be a result of unexpectedly low R&D spending (down 6% overall and down almost 1% as a percentage of sales).

Will new quad cans change the dynamics in CRM?
The theme for at least 18 months now in the CRM market has been that St. Jude continues to defy expectation and gain share while Boston Scientific spins its wheels. Even mighty Medtronic  (NYSE: MDT  ) appears to have seen some modest share loss to St. Jude over that time.

This quarter was another disappointment for Boston Scientific, and it also highlights that as promising as the S-ICD product may be, it is going to take time for this product to grow. Physicians are basically conducting their own trials with the product, implanting it in a small number of particularly well-suited patients and seeing how they fare before using it more widely.

In the near term, though, the recent approvals of the Dynagen X4 and Inogen X4 "quad cans" may give Boston Scientific a little spark. With 17 vectors (versus 10 for St. Jude), they should be successful products, but St. Jude has built a better CRM business than many seem to want to acknowledge.

What's the story in stents?
Boston Scientific saw 2% growth in its Cardiology business, with drug-eluting stent revenue down 4%. On one hand, that's almost 5% better than the sell-side expected. On the other hand, given Abbott's discussion of stent share loss, that overall result isn't as strong as it could have been and it seems reasonable to ask if the stent market has softened again. As a reminder, Boston Scientific has been looking to its Promus Premier and Synergy stents to change its fortunes for the better against Abbot and Medtronic, though the Synergy stent won't be available in the U.S. until 2015 or 2016.

Will new products live up to hopes?
Sell-side analysts have pinned a lot of their hopes on new products at Boston Scientific. Of the expected sales growth over the next three or four years, about half of it is expected to come from new products like the Sadra transcatheter valve, the Watchman LAA device, the Vessix renal denervation system, and the Alair bronchial thermoplasty device.

There are legitimate reasons to expect good things from these products. Unlike transcatheter valves from Medtronic and Edwards Lifesciences, Sadra is repositionable and retrievable and has shown lower leakage rates. The Watchman could generate hundreds of millions of dollars in revenue as a very economical option for reducing the risk of stroke by 50% or more, and Boston Scientific may be able to succeed where Medtronic failed in renal denervation on the basis of a different device design.

The "but" is that there is the example of Medtronic to consider – between disappointing clinical trial results, litigation, and other factors, Medtronic has lost some once-promising future revenue stars in just the last year. What's more, the Street is expecting Boston Scientific to go from being a very mediocre FCF generator (in the low double-digits) to a very good one (20%-plus FCF margin) in just five years.

The bottom line
I remain relatively unimpressed with Boston Scientific's prospects as a market-beating stock. Bard, Covidien, Medtronic, and even St. Jude all offer better DCF-implied annual returns at this level, though Boston Scientific remains undervalued on an EV/revenue basis. Boston Scientific's pipeline is still one of the more impressive ones in the med-tech space right now, but the company needs to start reporting "meet or beat" quarters instead of these misses if the stock is really going to be a leader in the sector.

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