Competing against the industry giants can be brutal, so it can pay off to sidestep the competition by thinking small. That's the strategy that LeMaitre Vascular (NASDAQ:LMAT) has employed for decades to drive market-beating returns.
In this episode of The Motley Fool's Industry Focus: Healthcare, host Kristine Harjes is joined by Motley Fool contributor Brian Feroldi to discuss how LeMaitre Vascular's focus on niche surgical products has been hugely rewarding for shareholders.
A full transcript follows the video.
This video was recorded on Aug. 22, 2018.
Kristine Harjes: Company No. 1 is called LeMaitre Vascular. Their ticker is LMAT. Brain, you're actually heading to their headquarters tomorrow.
Brian Feroldi: Yeah, I'm going to go check it out and get to see some of the products up close. I'm pretty excited about that!
Harjes: And what are those products? What exactly do they do?
Feroldi: LeMaitre Vascular, as you probably guessed from their name, they cater to the needs of vascular surgeons. For those who don't know, vascular surgery is surgery of the veins and the arteries, the circular system, that takes place outside of the heart. What these guys do is, they sell 14 different product lines that are used in vascular surgery -- products like grafts, patches, tape, catheters, those kinds of things. Except, while the vascular market in general is pretty large -- it's about a $5 billion market -- what LeMaitre Vascular does to compete is, they focus on niche product markets. They look for product categories that have less than $150 million in annual sales. They look to dominate a whole bunch of niche markets, as opposed to competing against the large companies. By taking a niche focus, it insulates them from competition.
Harjes: They're basically going after the niches of the market that are too small potatoes for a Goliath like a Johnson & Johnson. They have these 15 different product lines. The vast majority of their products hold the No. 1 or No. 2 market share position, which means they're doing a pretty good job. They have this eye for quality, which is likely derived from the fact that this is a family business that was started by George LeMaitre, who was a vascular surgeon.
Feroldi: The story is, the business was founded in the 1980s by a vascular surgeon who was frustrated with the products that were available at the time. He hired an engineer to create some new ones. He ended up founding this business. His son actually took over as CEO of the business a few years in. That was 26 years ago. While they are publicly traded, it was started by a vascular surgeon, and it's been run by his son, the CEO, for the last 26 years. And while they were small, initially, they have, through organic product innovation and through making acquisitions, compiled together a pretty impressive group of products that -- as you said -- holds the No. 1 or No. 2 market share in their niches. When you cobble all those together, the company did about $100 million in revenue. That isn't an enormous number in the grand scheme of things, but that is still big enough for this company to be profitable, cash flow positive, and their balance sheet is just pristine. It has over $50 million in cash and zero debt. If you look at the financials of this business, it's very attractive.
Harjes: And given that they're only selling about $100 million in annual revenue right now, there's a huge potential for growth, too. Their total addressable market is supposedly $1 billion. There could potentially be a huge growth runway in front of this company. Given that they are a smaller company pursuing growth, something that really stood out to me about them as quirky is the fact that they pay a dividend. Why is that?
Feroldi: That's a great question that I'm going to actually ask management tomorrow. I would personally prefer to see them retain all of their capital and use it to either pump more into R&D or to make acquisitions. But since they're a family run business, perhaps the CEO just wanted to have some more income for himself. The insiders in general of this business hold about 19% of the total shares outstanding, so they do have an incentive to pay a small dividend.
But, to your point, Kristine, what I like about this company is, its growth strategy is pretty straightforward. Because they operate in these niche markets, they have much more pricing power than they would if they were competing against, like you said, Johnson & Johnson or Medtronic on a day to day basis. Each year, they push through 3-4% price increases on their products, and they add a few more sales reps to their team. They have about 100 in total. When you combine in occasional acquisitions, they've grown their revenue at a modest 11% rate over the last five years. They've translated that into something like 45% growth in earnings through margin enhancements. It's modest growth on the top line that translates into very strong growth in the bottom line.
Harjes: And the market has given this company a $717 million market cap, which has fluctuated a good bit. They fell pretty hard in April after reporting disappointing earnings. They still haven't fully recovered. By most every metric, they're pretty expensive. What do you think of their valuation?
Feroldi: I think it does boast a premium valuation, and that's because of their consistency, their niche focus, and all the attributes that we just ran through. Having said that, though, this company is up more than 500% since its IPO in 2006. It has already thrashed the market, and I see a pretty clear pathway to continue posting regular earnings growth. So, while investors would have to pay a premium price tag to get their hands on it today, it might be worth it.
Harjes: Awesome. As you go visit them tomorrow, what other questions are top of mind?
Feroldi: I always like to ask about their long-term strategy with M&A. I always like to dig into the culture of a business and learn more about how employees are recruited, trained, and retained. I plan on digging into that.
Harjes: Great! I'm sure you'll be writing an article after the trip?
Feroldi: You can look forward to it, yes!
Harjes: Listeners, if you're interested in it, shoot us a note at firstname.lastname@example.org and we'll be happy to send it along once it is complete and published on fool.com.
Brian Feroldi has no position in any of the stocks mentioned. Kristine Harjes owns shares of Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson and Medtronic and has the following options: short October 2018 $135 calls on Johnson & Johnson. The Motley Fool has a disclosure policy.