3 Medtech Companies to Watch

In this week's episode of Industry Focus: Healthcare, host Shannon Jones talks with the Fool's med-tech guru, contributor Brian Feroldi, about three exciting companies listeners will want to add to their watch lists. Learn more about the businesses behind Cutera (CUTR 4.08%), Novocure (NVCR -0.89%), and Nevro (NVRO -7.11%) -- what these med-tech companies do, how they could grow their market share, why they're so appealing for the long term, how they've done in the past few years, the most important risks and metrics to watch, and more. Plus, the hosts share which of the three seems like the best buy now. Tune in to hear more.

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This video was recorded on Nov. 6, 2019.

Shannon Jones: Hello and welcome to Industry Focus, the show that dives into a different sector of the stock market every single day. Today is Wednesday, November the 6th. We're talking Healthcare. I'm your host, Shannon Jones, and I am super excited because I have live in the flesh Brian Feroldi here in the studio at Motley Fool global headquarters here in Alexandria. Brian, so glad to actually see you! To all of our viewers and listeners, he's not a bot. 

Brian Feroldi: That's correct! I do exist. No, it's so awesome to be here! I love coming down to the Fool headquarters to do these things in person! They make it so much better.

Jones: Yes. Brian is really our resident med-tech specialist. He keeps us in the loop with all things med-tech and some of the companies that really fly under the radar. So I'm super excited to have you in the studio today, because we're actually going to do a look-back. We've talked about a lot of different med-tech stocks, but today's show is really about talking about the best-performing med-tech stocks so far this year, two of which we've talked about before, but one we haven't, that I'm really excited to dig into.

Feroldi: Yeah. You know me, I love digging into companies that are under most people's radar, that a lot of individuals tend to ignore. Love doing this kind of stuff. Thanks for having me.

Jones: Yes, anytime. Let's dive right in. The newcomer to our Industry Focus: Healthcare show is none other than Cutera, that is ticker symbol CUTR. This is, from a high level a global aesthetic company, one that's been on the public market since about 2004. This was a stock we actually saw a pullback quite a bit in 2018, but this year has really taken off. But before we get into that, Brian, let's just talk a little bit about, what is it exactly that they do?

Feroldi: Sure, Cutera, they are basically focused on the aesthetics market. They sell systems that handle things for dermatological and plastic surgery procedures. They do things like body shaping, hair removal, tattoo removal, skin revitalization, those kind of things. They have a worldwide global system, about 10,000 of these systems that they have installed all over the world. This is actually a very attractive market. It's not one that we've talked about much. This is along the order of $10 billion in global sales. A big benefit that the aesthetics market has is that it's 100% cash pay. There's no insurance coverage to deal with. People are going to these, these are optional treatments. The cash-pay nature of them, and the growing demand to look better for the Instagram world is a real big tailwind behind this business. 

This company has traditionally sold these systems directly to plastic surgeons and dermatologists. They have steadily shifted toward a razor and blade business model that we know works very well for other companies. Their newer systems have a consumable component that previous devices did not. We're starting to see that trickle through the financial statements. I think that's a big reason why this stock has done so well in 2019, up 94%. Big bounce back.

Jones: Yes, up 94%. This is a company, it's got six different verticals, as you mentioned, covering everything from body contouring to hair removal. They are targeting those physician offices, the dermatologists, the plastic surgeons. They're really focused on non-invasive techniques, which I think have really gained a lot of steam, as you mentioned, in the Instagram culture of our day, and even with, I think, a lot of baby boomers that want to be forever young. I think that's another trend that they've been riding on. 

But just to get some context on one of their machines, they do manufacture something called truSculpt iD. Sculpting is basically melting or freezing fat from the outside in to destroy those fat cells. For a company like this, basically, it's all non-invasive. Treatments can take as little as 15 minutes, which is pretty huge in our convenience culture, if you will, too, especially compared to competitors, where their treatment times can go 60 minutes to 140 minutes or longer. With this company, they're also offering this at about half the cost. It's pretty remarkable. They're going after the convenience factor, they're also going after the undercutting on price. And they actually have pretty good results. We can see upwards of 11% to 25% of fat cells destroyed with sculpting techniques overall, there toward the upper end of that range. And this was the first technology to target patients that had a higher BMI, like a BMI of 30 or above. 

This is a really intriguing company in and of itself. That's only one of the systems that they have. And as you mentioned, this is a huge market. I think, as you talk about the Instagram culture, and the trends that are really driving the stock, at the same time, though, I have a little bit of pause, Brian, because when you think about aesthetics and beauty, oftentimes those are the first things that are cut in an economic recession. I actually went back and looked at revenues. Right around the 2008 financial crisis, they went down as low as $53 million in 2009. Obviously, they've been able to really boost and I think focus their efforts since 2009. But just talking about revenues, talking about where they're at, can you give us a picture of their most recent quarter and what we're looking at?

Feroldi: Yeah. As we previously mentioned, they have newer systems that are on the market that have more of a consumable focus. Because they're shifting more toward that model, their revenue growth isn't actually as high as you would think it would be for a company that's up almost 100% year to date. Last quarter, total revenue growth of about 12%. Consumables are now about 21% of total revenue, but growing very quickly. Consumables, as we have seen with many other companies, are very high-margin. So that's helping to lift this company's overall gross margin profile up 100 basis points. 

Something that I found very great about this company was, they're actually profitable. They produced a small, $600,000, net income last quarter. 

Jones: We'll take it. 

Feroldi: We will absolutely take it. But, to your point, if a global recession did hit, this is a completely optional procedure, so they will probably take some hits on the revenue side if something bad was to happen. But the financials of this company are actually very impressive. Growing revenue at double-digit rates, and their balance sheet is squeaky clean. $32 million in cash, no long-term debt. For 2019, they're estimated to do about $175 million in revenue. This is actually a relatively small business, about $450 million market cap. It does, I think, again, fly under the radar of most investors. But if you dig into the numbers and you see that the aesthetics market is absolutely enormous and continues to grow at about a 10% annual rate, $10 billion revenue opportunity, there's reason to believe this company can continue to win.

Jones: Yeah. But, I mean, you have to remember, too, this is also a very competitive space. They've had competitors, some of which have gone under, some that actually ended up going private. These are companies like Cynosure, Lumenis, Syneron Medical, and, of course, Allergan, which is a huge company we talk about all the time on the Industry Focus: Healthcare show. 

But let's talk about how they're priced right now, especially in relation to their earnings and their sales. What does that look like, Brian? 

Feroldi: Sure. This business is priced for growth. They're trading at about 90X next year's earnings estimates, about 3 times sales. Wall Street has bid up the stock to a very high valuation because they're expecting this company to continue to grow, to continue to produce good numbers. Analysts right now are modeling for about 25% annualized EPS growth over the next five years. If they can hit that, the stock seems expensive, but not crazy. I think this company can continue to win, but there's definitely risks.

Jones: Yeah, definitely some risks there. Certainly not for the weak at heart when it comes to volatility. Let's shift gears, though. Let's talk about a company that we actually talked about before. I think it was back in June when we had our med-tech show talking about Nevro, and that is ticker symbol NVRO. This was a turnaround story that we really dove into. When we chatted back in June, the stock was up about 61% year to date. They were really coming off at pretty dismal 2018. The stock was down I think 43% just in 2018. But right now, Nevro's stock's doing quite well. Brian, can you tell us how well they're doing and also, too, give us a quick refresher on what exactly they do?

Feroldi: Nevro is a company that's focused on chronic pain. They compete in a product category market called neuro modulation, which is essentially when a device is implanted and connects directly to the spinal cord to stop or regulate pain. These guys have developed a better mousetrap. This is a market that has existed, but their technology has come in and it's smaller, it's more effective, it's clinically proven to be superior, and importantly, their explant rate, which is when a device has to be taken out of a patient because it's not working, is less than half of the industry average. Those factors have helped them to steadily take market share in the market for many years. 

The other thing they have going for them is, this is a device that can be used as an alternative for opioids. We've seen so much in the news about the big problems that this country is facing with abuse of opioids. This technology is gaining steam because it helps to get people off of opioids. Again, it's for people that have serious long-term chronic pain. 

Growing very nicely for many years, and they really hit a brick wall in 2018. Their growth just came to an absolute standstill. That caused all kinds of problems. The CEO was thrown out, activist investors got involved. They've reshuffled the management team. A new CEO has been brought in to fix the problem. And as we can tell from the stock price performance, shares are up 122% since the beginning of the year, Wall Street is buying into this company's growth story yet again. 

If you look at the recent results, you probably have some questions as to why this stock's doing so well. Revenue was down 3% recently year over year. That doesn't exactly scream, "Wow, the turnaround is working." But management was very explicit that that was because of customer destocking, as opposed to them not being able to grow market share. That was just a managerial decision, related to some of their sales practices. Their gross margin is still very strong, 68%. Still losing money. Net loss was $26 million. That was up substantially year over year. But they have plenty of cash on the balance sheet. $234 million. 

But the big story here is that Wall Street believes that the new CEO that was brought in is here to fix the ship, and he has a realistic plan that's going to work.

Jones: Yes. Speaking of that CEO, he's an industry veteran. This is Keith Grossman. He's got over 30 years of medical device experience, including two stints as a CEO for two companies that actually ended up getting acquired. One of those was actually ThorTech. That was acquired by St. Jude for $3.4 billion in 2015. And then Conceptus, which was acquired by Bayer for $1.1 billion back in 2013. So obviously, you've got some people watching to see, could this be a takeover target? But, to your point, I think a lot of investors are saying, OK, we've got someone who's got experience and can right the ship. I think he took the helm in the spring of this year, so it's still fairly early. In May, he actually outlined at least a rough draft of what his plan is moving forward. There's still a lot to see and a lot for them to execute on. To point, like you look at earnings, and you're like, why is this company even up? But I really think it does come down to the CEO, but also, they've got some pretty unique growth opportunities moving forward. They've got the Omnia platform. That's set to launch sometime later this year. Basically an enhancement of one of their earlier models. And then they're also going after an indication, something called peripheral diabetic neuropathy, or PDN. This is something that diabetic patients experience all the time, about four million suffer here in the U.S. from it. They just actually completed enrollment for a multicenter trial for the treatment of PDN. We should start to get results heading into 2020 for that. That's going to be a huge opportunity. But when we're talking about opportunities, Brian, just how big of a market is Nevro going after right here?

Feroldi: Right now, they peg their total addressable market opportunity at about $2.25 billion. That's in their current indications. To your point, they do have several label expansion claims in the works. They're going after neck pain, diabetic neuropathy, refractory back pain, abdominal pain, and more. If all those work out, management believes that they can get their TAM up to $4 billion annually. For perspective, this is a company that's doing about $387 million in revenue this year. They've penetrated a decent amount of the market, but there's still room to grow if everything works out. 

But the big story here for investors is that Wall Street believes that this CEO is the real deal. I think that if you look at his career, there's reason to believe that. The company itself wasn't fundamentally broken. The thought was that the prior management team just wasn't getting it done. If that thesis proves correct, there's ample room for this company to continue to grow and eventually flip to profitability.

Jones: Absolutely. So a lot to like here. And I think, too, even with this new CEO, he came in and immediately said, "It's not about the quantity of the salesforce, it's really about the quality of that salesforce." So he's really been investing heavily. Of course, we saw losses almost triple, I think, in the most recent quarter. But it's because he's investing so heavily in the areas that matter. This is definitely a turnaround story to watch. But in terms of how the stock is priced, Brian, what are we looking at here?

Feroldi: 7X sales. Not insane valuation if the company can deliver on its growth expectations. But, pretty high. Again, Wall Street believes that the CEO can do the right thing. But it does show just how cheap shares were at the start of the year, and how little faith Wall Street had in the old management team. The huge returns that we've seen so far this year I don't think are going to be repeated, but there's definitely the potential for solid returns from here going forward.

Jones: Absolutely. Yes. Huge runway for growth. All right, let's talk about our third stock. This is a stock that I can admit I was very cautiously skeptical about when it was first brought to me. I know you and I have talked about this. But this is none other than Novocure, ticker symbol NVCR. I will admit, Brian, I've been won over. And apparently, other investors are, too. Stock is up 125% year to date. Before we get into that, though, let's just remind all of our listeners, what exactly do they do?

Feroldi: Yeah, this is one of my favorite medical device companies to talk about, period, because it's been so controversial, when you hear about what this company does, and how crazy their technology is. They have developed a brand-new modality of treatment that they call Tumor Treating Fields. It's basically a non-invasive medical device that is used to stop or slow cell division in cancerous tumors. The way this device works is, basically, it's a funny-looking cap, you put it on your head, it has these electrodes coming off it. 

Jones: It's like an electrified skullcap, basically.

Feroldi: That's exactly what it looks. You turn this device on, and it creates an electric field. Those electric fields work to inhibit cell division in cancers because some of the particles that are in cancer cells that divide are very reactive to electric fields. So, by tuning this product to a very specific frequency, it actually prevents cell division. It's wild. The biggest benefit of this technology is that there's basically no side effects at all. You're just wearing it, you flip a switch, everything else looks exactly the same. But, this works to fight cancer. 

When this first came out, people were very skeptical about how crazy this idea was. But Novocure has steadily produced clinical results that have not only convinced regulators, but they've also convinced healthcare providers and payers that this technology works. Their first market was going after a deadly form of brain cancer called glioblastoma multiforme. They currently have 2,700 patients that are using this device each month to treat that. 

This company has produced fantastic financial results. Their growth has been astronomical as more and more skeptics like yourself are turned into believers. Last quarter, this company hit a home run with its earnings report. Revenue was up 41% to $92 million. That helped them expand their gross margin up to 75%. Fast revenue growth, plus increasing gross margin, just creates magic. They actually crossed into profitability for the first time ever. They produced a net income of $2 million when analysts were expecting a loss. Everything is going right at this company right now.

Jones: So, so true. I mean, you talked about the GBM, the glioblastoma indication. I really can't underscore just how significant their second approval for mesothelioma was for them. Basically, a few months ago, they did get FDA approval for their first torso indication. There was a lot of concerns with analysts and investors, like, if you put on a skullcap, I can see how these electrical fields could inhibit cell growth, but what about some of the other solid tumors when you start talking about other body parts? So, they answered that. They got the approval. And I think, not only that, but it also opens up the door for even more oncology indications moving forward. I know one of which is non-small-cell lung cancer. This is a huge indication. We've talked about it a lot on Industry Focus: Healthcare. This is an indication that's really dominated by these checkpoint inhibitors. These are drugs. There's some thought that they could go after this market now that they've got this torso indication. There's also some thought that, hey, this could be used in conjunction with radiation and some of the other anti-cancer treatments. If you think about just how huge the oncology market is, and how we're starting to see this company progress with winning these very key approvals, I get more and more excited about this company.

Feroldi: Yeah. I think two things really attracted me to Novocure. The first was that the treatment itself was so non-invasive, so easy for patients to use. You compare that to chemotherapy, radiation, those are just highly invasive procedures. This, by contrast, is super simple to use. More importantly, this is not a rival to those treatments; this works in conjunction with them. These guys aren't trying to go out and replace something that exists; they're trying to give people another tool, basically, in the fight. And, again, they have the clinical data to show that, yes, this does work.

To your point about moving into label expansion claims, that's, I think, a big reason why we've seen this stock perform so well this year. The market for glioblastoma is actually pretty limited. There's about 13,000 new diagnoses in their core markets every year. Again, they have about 2,700 patients right now. So, there is still room for them to grow in their core markets. Mesothelioma is not a big market, thankfully. It's only a few thousand patients in the U.S. A couple of more if you add in international. The big potential for this company is label expansion into brain metastases, lung cancer, pancreatic cancer, ovarian cancer. When you add those together, you're talking about hundreds of thousands of potential new users for this device. All of those markets are currently in Phase III trials. The company is literally within a year or two of launching into those markets. If that works out, this company's TAM explodes.

Jones: Yes. That's so true. There's just so many good things happening with this company. They also saw Medicare reimbursement kick in for the first time. It was only about, I think, $500,000 in Q3, but to see now payers getting on board with this company is only another notch in their belt, and really continues to give them validation. And it's not just the label expansions. They are also expanding internationally. They've got a partner with Zai Labs, I believe, in China. The glioblastoma market there is about 45,000 people diagnosed every year there. So, that, again, is just another opportunity. 

But in terms of valuation, Brian, how are we looking in terms of where this stock is priced?

Feroldi: Yeah, its priced for growth. I mean, there's no doubt about it. You can't go up more than 100% in a year and not be priced for growth. You're talking about 24X trailing sales. There's actually a PE ratio here, a forward PE ratio --

Jones: So rare to see!

Feroldi: I know, right? 206X. That number shouldn't concern investors, [laughs] because this company is still in the very early stages of scaling. To me, it's very pricey right now. But if the company is successful in any of those other indications, that valuation is clearly worth it. I think there's enormous room for this company to grow. But, there's no doubt that the valuation does make things risky.

Jones: Yeah, certainly makes things risky, and gives you some pause. But, of course, now that we've gone through three stocks, I have to ask, Brian, which of these three right now would you say is your top pick?

Feroldi: Oh, I can hear the listeners screaming at me about which one I'm going to pick. I've been bullish on Novocure for several years now, and I'm definitely going to pick it of my three. I think that Cutera is actually a very interesting company. I do like the market that they're in. I do like their shift to recurring revenue. That's definitely one to watch. Again, under $500 million. That's a company that could generate strong returns for investors. The financials are actually pretty attractive. Nevro is one that's still in turnaround mode. I think it's gotten a lot of credit, and the numbers don't yet back that up. That's definitely one that I'm going to continue to watch. But, between the three, Novocure is definitely my pick. How about you?

Jones: I'm going to have to say Novocure! This is an easy one for me, though. But I don't want to underscore, especially with Nevro, I think this is the turnaround story to watch. If the new CEO can come in, right this ship, and really go after the opportunity -- I mean, pain management is just such a huge market. You talked about the opioid crisis. I can get behind that, right? I can get behind something that's not a drug, and I can get behind a company that is attempting to go after something meaningful. Novocure, though, just has to be my pick. 

Feroldi: We've made you a believer!

Jones: You've made me a believer. I'm still watching. [laughs] We'll see if I actually get invested. But at least, for all of our listeners, hopefully, you've got now three stocks to keep on your watch list if not go ahead and start thinking about adding to your portfolio. Again, this is not for the faint of heart. You must have a very thick stomach, a gut of steel, to ride some of the volatility based on these valuations. But hopefully, you got some ideas.

Brian, always a treat to chat with you! I'm just always excited when you're here at Fool HQ!

Feroldi: Always great to be here, Shannon! Thanks for having me!

Jones: Thank you to all of our viewers and our listeners for tuning in! That'll do it for this week's Industry Focus: Healthcare show! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is being mixed by Austin Morgan. For Brian Feroldi, I'm Shannon Jones. Thanks for listening and Fool on!