Winners and Losers in Healthcare This Quarter

On this week's episode of Industry Focus: Healthcare, host Shannon Jones and Motley Fool contributor Brian Feroldi catch listeners up on four companies we've talked about before: Abiomed (ABMD), Inogen (INGN -0.74%), Guardant Health (GH 9.46%), and ShockWave Medical (SWAV -0.12%). Listen in to find out what each of these businesses does, and what updates they brought to the table this quarter -- from Abiomed's slow but steady recovery from the FDA debacle to ShockWave's shocking growth and more. Will Abiomed be able to move past its FDA letter troubles? Should investors worry about Inogen's sales snafu? Just how big can Guardant Health get? Is ShockWave worth its 65 times trailing sales multiple? Tune in to learn more!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on Aug. 21, 2019.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every single day. Today is Wednesday, August the 21st, and we're talking Healthcare. I'm your host, Shannon Jones, and I am joined via Skype by Fool.com contributor and medtech guru Brian Feroldi. Brian, how's it going?

Brian Feroldi: Hey, Shannon! At my house, we're at the end of summer camp season, and school doesn't start for two weeks, so I'm playing daddy day care for the next couple of weeks. That's what's happening with me. What's up with you?

Jones: Hey, I feel your pain! My daughter is also starting school again here in the next couple of weeks. Just got back from taking her to grandma's house for a week. Honestly, this is a very quiet week for me on the home front, but I'm so ready for those kids to go back to school.

Feroldi: I cannot wait! I have all three of mine going on the bus in two weeks and I'm counting down the days.

Jones: I hear you! Well, let's talk about some of the stocks making the headlines. Brian, always a joy to have you on the show to talk about medtech, med devices, that entire industry. For today's show, though, we're going to be talking about the biggest winners and losers coming off of a very busy earnings season. We've got two winners, two losers. Before we get into all of that, Brian, I think it's probably good to pre-emptively say that, of course, we're long-term investors here at The Motley Fool, and even though we're looking right now at a snapshot, one quarter, it does take more than one good quarter, even one bad quarter, for us to change our long-term thesis. Oftentimes, we're looking at over the next three to five years, if not longer. And, really, Brian, any good company out there, any very well-run company out there, will have a bad quarter. I think that's fair to say, right?

Feroldi: Yes. The research clearly shows that happens. Every company. Even the almighty Berkshire Hathaway has been smashed multiple times in its history. As Fools, we do look at the quarterly numbers, and we don't necessarily change our investing thesis, but we do take into account short-term results to alter whether or not we are bullish, or if a stock is a long-term buy or if it's a hold. Problems happen to every company; the big question that you have to determine as an investor is, are these short-term in nature, or is there something systematically wrong with the business?

Jones: Excellently said! I love that there! We're looking for trends, we're looking out over the long term. Let's start with the first loser coming out of earnings, and that would be none other than Inogen, ticker INGN. Brian, you and I did a show earlier this month about the very lucrative respiratory disease market. This was the company that was founded by college students on a mission inspired by one of their grandmothers who had to carry around a heavy oxygen tank, a story I can get around. We see a lot of the founders still involved with the business. In that show, we did talk about their business model, how they make money; but we also talked about some of the headwinds they had been experiencing up until that point. It sounds like second quarter, still, headwinds are ongoing. Before we dive into that, though, Brian, let's just do a quick refresher of what it is that they focus on.

Feroldi: Yeah. Inogen was the innovator of portable oxygen concentrators. As we spoke about on our last show, there are a number of patients out there that need supplemental oxygen therapy to help them get the oxygen they need because they have reduced lung capacity for a variety of reasons. The No. 1 cause is typically a long life of smoking, where your lungs can no longer absorb the amount of oxygen that they need. A portable oxygen concentrator is a very miniaturize device that actually continuously creates concentrated oxygen from the surrounding area. It's smaller, it's very quiet, it's much more convenient for patients to carry this around than having to lug oxygen tanks behind them. These guys were taking heavy market share in the oxygen therapy market for years. This company came public a few years ago. It was a red-hot stock. This company was just humming along, growing at a double-digit rate, profitable, cash flow positive, clean balance sheet, everything was going splendidly. And then the wheels started to fall off the bus about six months ago. Their revenue growth significantly slowed due to reimbursement headwinds and some employee challenges with sales execution. We noted in our last show that perhaps the stock may have been a value, when we brought it up a month ago. Well, the stock price is now significantly cheaper than it was even a few weeks ago based on their Q2 results. Q2 results were just not good at all. Revenue growth slowed all the way to just 4% revenue growth. That was well shy of what Wall Street was looking for. Gross margin fell. Expenses jumped. That combination just caused net income to crater 30%. So, it dropped significantly vs. the year-ago period. And I think the thing that capped it off with Wall Street was that they cut their guidance for the year. Previously, they were expecting $405 million to $415 million in revenue. They dropped that number all the way down to $372 million to $375 million. Wall Street was not happy.

Jones: Not happy, to say the least. Last quarter, management, as you mentioned, was talking about some reimbursement headwinds, also talking about productivity with some of their new hires on the sales side. Also, we talked a little bit about them shifting their business model to more of that rental model, to try to see some of that recurring income. Obviously, anytime you're shifting revenue mix, there's going to be some short-term pain, which hopefully should play out over the long term, we hope. All in all, it still sounds like there's a lot of blame being put on the sales staff, and it sounds like they even had to cut some from the sales staff.

Feroldi: Yeah. That's exactly what the CEO, Scott Wilkinson, said. He basically said, "The level of sales representation attrition was higher than we expected, and many of our new hires were unable to meet their sales targets." That to me sounds like there's a hiring issue and potentially an internal cultural issue that is repelling salespeople. There could be something underlying going on that is preventing these new sales hires from meeting their targets. In my opinion, this could be a sign of something not going right at the company, as opposed to just a one-time blip.

Jones: Yeah. And, to the surprise of many, they also announced an acquisition, a company called New Aera that makes portable non-invasive ventilators. This was a $70 million in-cash deal. Up to $31 million in potential earn-outs. What are your thoughts about this acquisition? Does that change where the company is within the short term? What do you think about that?

Feroldi: Quick look at the acquisition, I think it makes sense. The company that they acquired, as you said, $71 million, plus another $30 million in earn-outs if certain targets are met. They make non-invasive ventilators that are designed for patients with chronic lung disease that need higher levels of oxygen. They produce products that create higher flow rates, higher pressure. It looks like an acquisition that really makes sense for this business. They said it's going to be accretive to sales starting next year. Gross margin could increase from it. It will leverage a lot of their existing infrastructure. So, on the surface, this looks like a smart deal. 

The thing that I worry about is, is this their way of buying growth because their core business is not executing. And, potentially, could this be an unwanted distraction for the business when they should be paying attention to reexecuting and getting their core business on target? So, high-level, I think the deal makes sense. I'm not sure if right now is the perfect time for them to make the acquisition.

Jones: Yeah, great points there. Management did say they're hoping to return to double-digit top line growth here in 2020. This sounds like a story we're just going to have to wait and see. I'm not entirely confident. But let's keep the show going, because we've got another loser. 

This one kind of hurts my heart, Brian. This is a company that has just been beaten down over the past year and a half. That is none other than Abiomed, ticker ABMD, a leader in what's known as the heart recovery field. The hits just keep on coming, Brian. When you look at the stock price just over the last year and a half, the stock is down right now about 56% from its high. You and I talked about this company in May most recently. Before we get into their fiscal first quarter of 2020, let's just give a quick refresher. What is it that Abiomed actually does, and what's their tech? 

Feroldi: Sure. Abiomed makes minimally invasive temporary heart pumps that are put into a patient's heart either after they've had a heart attack, to keep the blood flowing and alleviate the pressure that's placed on the heart so it can recover; or, it's also used before a heart surgery is performed on a very high-risk patient, and it basically makes a high-risk surgery a lot safer, it lowers the risk profile. These guys have the data to show that when you use this device, it leads to much safer outcomes, faster recovery, so they're out of the hospital faster. Abiomed is really the only company that does what they do with minimally invasive heart pumps. These guys have been crushing it for years, and Wall Street really bid up this stock to very, very high levels. I mean, price to sales ratio was above 20X, just about a year ago, 18 months ago. But they definitely deserved it. They were putting up unbelievably consistent growth, margins were expanding, they were profitable, they have tons of cash, no debt, they were just a rock star company. 

But, as we talked about the last time we talked about them, in February of this year, the FDA issued a warning letter to healthcare providers that made it seem like one of their heart pumps was not safe to use, and it was being recalled. That was not the intent of the letter, but the media picked it up and it just spread like wildfire, and Abiomed has basically been in damage control mode since February. So, that letter came out, and they actually missed their first quarter earnings targets for the first time in basically years. They said that they were going to refocus their efforts, redouble down on education to make sure that the medical community was aware of what's happening. In fact, in May -- just a couple of months ago -- the FDA issued another letter basically saying that the product in question was safe to use and was effective. So, Abiomed has been going around with that letter and letting the medical community know that, yes, indeed, everything is as we said. But, since that letter didn't come out until May, Abiomed hasn't had enough time to reverse the damage, and we saw that reflected in their Q2 sales results. Revenue grew 15% to $207 million in the quarter, which sounds really good, but that was short of the $211 million that Wall Street was expecting. The sales missed. The gross margin declined a little bit. Earnings did OK. GAAP earnings fell 1%, but adjusted earnings were actually up much more. This company has some one-time adjustments in its numbers based on some equity investments that it's made. But the big shocker here was that they lowered their full-year guidance. They were previously guiding for $900 million to $945 million in full-year revenue. They pulled that back to $885 million to $925 million. That represents growth of about 15% to 20%, but Wall Street was just not happy with the guidance reduction. On the day of this report, their stock was just crushed. Down 28% in one day on the news.

Jones: With the stock down like that, Brian, it looks like right now it's trading for about 11X sales. Certainly off of its highs. Do you think perhaps right now Abiomed is past the worst of it? That's just going to take time for the reeducation to regain the trust of the physicians and patients? Do you feel like we've already hit a bottom, if you will?

Feroldi: In my personal opinion, I think the answer is yes. I view this as a wound that basically Abiomed had nothing to do with, and they've been in recovery mode ever since. But if you zoom out to the bigger picture, the opportunity here is still massive. Abiomed's market share in their treated fields are still single-digit, even in the U.S. They're expanding internationally, particularly in Germany and Japan. In fact, they knew that Wall Street wasn't going to react well to this, so they immediately announced a $200 million stock buyback authorization. They also won FDA approval for a new Impella device during the quarter, and their balance sheet remains flawless. $527 million in cash and no debt, so they will have no problems affording every program that they have going on and being able to buy back stock. So, I personally view this as a blip in the road as opposed to something that damages the long-term story.

Jones: Alright. Now it's time to talk about some of our earnings winners. Brian, the first medtech winner is one I know you have been diving deep into lately, and that is ShockWave Medical, ticker SWAV. This is a company you were first excited about when you found out that Abiomed, the company we just referenced, took an equity position in ShockWave prior to its IPO. We did a show all about this company. Let's get folks up to speed. What is it that ShockWave does?

Feroldi: Like Abiomed, Shockwave is focused on cardiovascular disease. What their innovation was is, they created an intravascular system that uses shock waves to break up hardened calcium deposits that are in arteries. When an artery becomes clogged with fatty buildups, over time, it can become rock-hard and calcify. Calcium is very, very difficult to treat. There's a number of techniques that are on the market today, but many of them involve either very high-pressure stents or even an artery roto-rooter, and those aren't the safest of surgeries. ShockWave, by using shock waves to break up the calcium, it's very, very safe technology because it only affects the hardened calcium and it basically has no effect on surrounding soft tissue. The technology that's behind this has been used to treat kidney stones for decades, so it's very well-understood. What Shockwave did that was innovative was, they miniaturized it and they used it in a different application. So, these guys have been a red-hot growth stock since their IPO. 

Their numbers just came out, and you understand why this company has just been on fire. We just saw revenue growth of 339%. Now, that was off of a small base, so the revenue came in at just $10 million. Still an impressive growth rate, for sure. That huge leverage allowed their gross margin to expand 1,100 basis points to almost 60%. Their net loss dropped to $10.6 million, which is well below what Wall Street was expecting. The nice results allowed them to raise their guidance for the full year. Previously, they were expecting $33 million to $36 million. Now, they're expecting $38 million to $40 million. Looking a little further down the road, a little later this year, they're expecting a new device to be launched in some limited markets, and a full launch later next year. That will be used for calcium deposits that are below the knee. 

Basically, all around, it was a solid quarter. Every number looked good. Shares popped on the news. This is still an extremely expensive stock. It's been all over the map. Even today, it's trading at about 65X trailing sales. But, when it comes to Q2 results, everything was great.

Jones: Yeah, everything was great. Really impressive stats. Granted, they have technology that's already been out there, they just combined it in a new, innovative way to go after a major market. Talking about market, the FDA approved the device in peripheral artery disease. That's a $1.7 billion market. Also, going after the larger coronary artery disease market, $2 billion there. And then, they've got an aortic stenosis opportunity, worth another $3 billion. So, this is a company with a very large runway, so not surprising to see the premium right now placed on shares of this company. All in all, really impressive quarter all around for this company. 

Let's talk about our second winner. Once we get through that one, we're going to pick Brian's brain for who he thinks is out ahead on top, and which one of these is a buy. But first, let's talk about Guardant Health, ticker GH, our next winner. This is a company really at the forefront of the fight on cancer, developing diagnostic tests to help drive detection and treatment earlier. Brian, what is it about Guardant Health exactly that they're doing that really makes them innovative in this space?

Feroldi: Guardant Health is a fascinating business. I don't know if we've ever talked about them on Industry Focus before. This is a company that is in the forefront of liquid biopsies. Currently, if you have a solid tumor cancer, the way that you diagnose it is to take a sample of it. And depending on where that sample is located, that often can mean invasive surgery, which is both expensive, risky, and the patient certainly doesn't like it. So, what Guardant's doing is, they're disrupting the way that we diagnose tumors. Instead of having to do a surgery to diagnose lung cancer, for example, now, Guardant's technology allows it to be diagnosed just with a simple blood draw. Instead of going in through your lungs and taking a tissue sample out and sending it off to the lab, Guardant not only speeds up the process, the test results come back much faster, but it saves the patient from having to go to unnecessary surgery, and it's also much, much cheaper. For context here, a traditional lung cancer biopsy costs about $14,000, whereas Guardant can diagnose that same cancer for $3,500. 

This is a very interesting technology that is a win for everybody in the healthcare system. And because of that, they have been posting explosive, explosive growth. Their technology can currently be used to detect dozens of cancers. Right now, they're just focused on late stage cancers in the solid tumor. But down the road, they hope to gradually advance the technology so they can diagnose it earlier and earlier. And when you get into that market, the market opportunity here is just enormous. We're talking about $30 billion plus just in the U.S. for that opportunity. This is a fascinating business.

jones: And that's $30 billion just here in the U.S. When you actually look out globally, that's potentially a $100 billion opportunity when you look across the landscape and see all the different indications that they're going after. We saw really strong uptake in this last quarter with their Guardant360 test. It's being used by more than 100,000 patients now, prescribed by over 6,000 oncologists. Guardant also partners with a lot of the biopharmaceutical companies we talk about on Industry Focus, really helping them develop what are called companion diagnostics that go with their treatments. And then, also, within just that segment alone, drug making partners used 5,285 tests during the quarter, up 112% year over year. Revenue within the development services segment jumped massively, 664% to $11.9 million. I think, all in all, when I look at that, I'm impressed to see uptake is increasing, they're expanding, they've got some optionality. What did that look like, though, in terms of quarterly performance?

Feroldi: In Q2, revenue jumped 178% to $54 million. Now, that number itself isn't all that impressive, but what is impressive is that Wall Street was expecting $36 million. Just a massive beat on the top line. And all that sales leverage allowed their gross margin to expand by 2,000 basis points, from 49% to 69% this quarter. When you combine huge sales growth with an expanding gross margin, their net loss plummeted to $11 million. Sounds like a big number, but this is a company with more than half a billion dollars in cash on its balance sheet. And because of that huge beat, they raised their guidance for the year. Previously, they were expecting $145 million to $150 million. Now, they're expecting $180 million to $190 million. Wall Street just eats that stuff up. This stock surged 21% on the day of the announcement, and it's just been a monster winner.

Jones: Brian, that brings us to -- we've talked about four stocks. Which one of the four in your opinion is a buy right now?

Feroldi: In my opinion, I think that Guardant and ShockWave are both super interesting. Growing very fast. Big opportunities. But, you have to really pay up for that growth. These are companies that are trading many, many multiples of their sales. Wall Street is certainly on it. Inogen could be an interesting value play here, but when I see something going wrong in the inside of the business, it's hard for me to get bullish. My personal view is to take a wait-and-see approach to them. I think that Abiomed is a great buy right now. I think they still have a huge opportunity ahead of them. They're still highly profitable. They're still posting double-digit growth, and that's even with this significant slowdown we've seen something that I believe is completely fixable in the long term. I will tell you that when The Fool's trading rules allowed, after the quarter came out, I went out and immediately added to my position. Under $200 a share, I think the valuation is attractive. The long-term opportunity is attractive. So, for me, Abiomed is the winner here. You?

Jones: Yeah, I can easily second Abiomed, for all the reasons that you just described. But I would say, too, granted, valuation aside, if I'm just looking at long-term business, I'm looking at the optionality, I get really excited about Guardant Health. And that's really where I think I'm going to give my edge. With the field of genomics comes the ability to diagnose and treat patients based on the genetic makeup of the disease. Guardant Health is one of the companies at the forefront of that, and really is truly paradigm-shifting when you think about cancer care, diagnosis, and treatment. I mentioned it's a $100 billion market opportunity. I'm always looking for big markets. Companies at the forefront of changing that paradigm with lots of optionality. I love all the partnerships that they have. I think you really can't go wrong with Abiomed, of course, but I think Guardant Health is one to consider for the long run.

Feroldi: Yeah, can't fault you there. Guardant, and ShockWave, are tremendously exciting businesses right now.

Jones: Yeah, all around. Well, that will do it for this week's Industry Focus! We want to thank all of our listeners for tuning in! As always, people on the program may have interest in the companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan, who is mixing it up for us behind the glass. For Brian Feroldi, I'm Shannon Jones. Thanks for listening and Fool on!