3 Aesthetics Stocks to Watch

The aesthetics market nets some $10 billion a year globally, and that's only getting bigger as procedures become more accessible.

In this week's episode of Industry Focus: Healthcare, The Motley Fool's Shannon Jones and Brian Feroldi dive into three small pure-play aesthetic surgery companies. Learn more about the aesthetics market in general, and then about Cutera (CUTR 3.92%), InMode (INMD 0.70%), and Sientra (SIEN 16.16%) specifically -- what these companies do; how they've performed for investors; where they can grow from here; what kinds of treatments they offer consumers; some risks to watch out for, especially with Sientra; which of the three the hosts like the most; and much more.

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This video was recorded on Nov. 26, 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, November the 27th, and we're talking healthcare. I'm your host, Shannon Jones, and I am joined via Skype by fool.com's health and tech specialist, none other than Brian Feroldi. Brian, how's it going?

Brian Feroldi: Hey, Shannon! I am in the middle of a massive kitchen remodel right now, so my house is absolutely crazy as of the moment. That's what's going on with me. Hopefully the listeners can figure out that your voice is not cooperating well today, so we're trying to keep your talking to a minimum.

Jones: Yes, thank you for that. Of course, wanted to make sure that we were able to get in this very special pre-Thanksgiving episode. Hopefully my voice will hang in there. But I'm excited for today's topic, because it's really a topic that we haven't really explored in depth on Industry Focus: Healthcare, but one that is certainly catching a lot of investors' attention, especially lately with the IPO market. And that is none other than the medical aesthetics market. Brian, I mean, this is a huge opportunity. We chatted just a few weeks ago about a couple of companies, some of which we'll cover today. But when it comes to this market, just how big of an opportunity are we looking at right now?

Feroldi: Yeah, the aesthetics market is -- and we're specifically talking about the medical aesthetics market -- far bigger than you would probably assume. In America, the sales in 2017 were about $8.5 billion. Globally, sales in 2017 were over $10 billion. So this is actually a very big market. What's attractive for investors, there's a couple of things that are attractive. First off, the entire industry is growing at about a 10% annualized rate. By 2024, global sales are estimated to be almost $19 billion. What's driving that is a gradual aging and graying of the global population combined with the obesity epidemic. And then, when you sprinkle in social pressure from social media and the Instagram generation, there's growing demand for aesthetic procedures. And, again, to give you some more numbers, each year, about 40 million laser procedures are performed worldwide. That includes hair removal, pigment lesions, leg vein removal, acne, and vascular lesions. From a surgical perspective, about 2.5 million plastic surgery procedures take place worldwide every year. The attractive things for investors about that market is not only is it huge, but there's no reimbursement. All of these procedures are cash pay. So you are completely eliminating an enormous risk with the payment right out of the model. So when you are a company that's playing into this market, that is highly attractive.

Jones: Yeah, that's such a great point, Brian. I think with a lot of physicians' offices now, there are some private practices that are really trying to open up and expand for the exact reason that you said. It's because there's no reimbursement involved. So now, they want to have kind of an aesthetic or even overall health and wellness component to their practice, because this is income that they don't have to rely on payers for.

You mentioned, of course, the very, very heavy Instagram culture, and even, too, the aging baby boomer market. I mean, everyone wants to stay forever young, and also look forever fit. So I think there's a lot driving this market. As I've said before when we've talked about this, my only hesitation is that with procedures like this, obviously, it is very much reliant on disposable income. That means the economy has to be humming along. Again, like we're seeing right now, unemployment is low, and so I think it makes a lot of sense to see growth in this space. But when and if a downturn hits, a recession hits, these will be some of the first procedures to go. But even with that, this is a space that is growing, it's becoming cheaper, a lot of these treatments now are faster, you don't require as many follow-on treatments, and the technology is improving. So this really is a space that investors can't afford to ignore any longer.

Feroldi: Yeah, I think that that's exactly right. You bring up an excellent point that these are optional procedures, and they can be delayed indefinitely through economic hardship. But the vanity culture is not going away, so it might be more resilient than investors are assuming. And, again, we're talking about billions of dollars in sales here. Even a contraction still generates enormous opportunity for individual companies like we're going to talk about today.

Jones: Yes. And speaking of companies, let's get to the first, and that is none other than InMode, ticker INMD. This is a company that really kind of quietly IPOed, I believe it was in early August, but has exploded since it debuted on to the market. Brian, this is an Israeli-based company really built around minimally invasive tech. What can you tell us about what it is that they do?

Feroldi: Yeah, so, to your point, InMode came public in August of this year, so just a few months ago, and they're already up almost 300% during that time. Wall Street has really taken a focus on this business. When you dig in, it's extremely impressive. What InMode does is, they sell minimally invasive aesthetic surgery equipment. They have a range of products that are used in plastic surgery. Their primary customers are gynecologists, dermatologists, ophthalmologists, and the like. What makes InMode special is, its technology is based on radio frequency that is applied directly to the skin and eviscerates fat tissue below the skin without scarring. Their technology can be used to liquefy unwanted fat below the neck, the arm, the belly. It can also be used to remove acne and wrinkles. And the results that they provide are very long-lasting without really a lot of the negatives that are associated with plastic surgery. So, when you get plastic surgery, very common to go under anesthesia, have a long recovery time, and have to deal with scarring. InMode's technology bypasses all that and provides, they say, all of the benefits without any of the negatives.

From an investor standpoint, they are pursuing a razor and blade business model. Right now, since they're still small and upcoming, 90% of their sales are coming from the razor, so, the machines themselves, and about 10% are from the consumables and contract agreements, which is what we should care about mostly as investors over the long term. But both numbers are growing pretty quickly. And although this is a relatively new company to the public markets, their products are actually available all over the world. They already have more than 4,400 of their units installed around the world. They're in 49 different countries. In the U.S., which is by far their biggest market, they already have more than 2,600 customers.

This company has only reported earnings twice since coming public, but the numbers that we've seen are incredibly impressive. Last quarter, they reported revenue growth of 57% to $40 million. Their gross margin, which jumped off the page to me, was up 100 basis points to 87%. The revenue number was better than expected, and that high of a gross margin allowed this company to crank out a net margin or a profit margin that was extremely high, $16.2 million in profit on $40 million in sales. That is incredibly impressive.

Jones: Yes. I mean, this is a company, when you look at the numbers, you get impressed. But really, in terms of where they have slotted into the market, they've positioned their technology in between the traditional surgery, which of course does have the scarring, the downtime, the anesthesia that's involved, and also the laser market. So, laser, of course, has been extremely popular. One of the companies we'll talk about has really carved out a niche for itself in the laser market. But they're really kind of slotting right in the middle. Basically, you have less downtime, less scarring, and also, too, potentially, better results. It doesn't require nearly as frequent treatments, but also potentially better results.

And for them, you talked about how they have been expanding around the globe. Worldwide, there are over 20 million aesthetic procedures performed annually. For InMode, their devices address 8 million of them right now. They've got a number of different devices. They're expanding globally. A lot to watch here.

I want to jump, though, and talk about another company in this space, because the competitive threats you really can't underscore, because it's not just InMode. There's another company in this space called Cutera, and also some bigger players in the space, too. You've got Allergan, you've got AbbVie as well. But let's talk about Cutera. This is a company we actually talked about a few weeks ago. But, Brian, for those listeners who may not be aware, not up to speed, what can you tell us about Cutera, and really how different is it from an InMode?

Feroldi: Sure. As you mentioned, we covered this company on our November 6th episode when we talked about some of the best-performing medtech stocks of 2019. One of those is Cutera, ticker CUTR. They are about a $500 million market cap company, so about a third the size of InMode currently. But what they do is, they focus on laser systems that are used in dermatological and plastic surgery procedures. They also help with body sculpting, hair removal. They also do tattoo removal, which is something that InMode does not do at the present, I believe. Cutera has been around for longer. Worldwide, they have over 10,000 of their systems installed. What we talked about, one of the reasons that Wall Street has really taken an interest in this business is, they are seriously shifting their business away from a capital sales business toward a razor and blade model. Their newer devices have a significant consumable sales portion to them, which helps generate more recurring revenue that's higher-margin. That strategy is taking hold and is one of the reasons why the stock has performed so well this year.

But as we saw in their most recent quarter, we saw revenue growth of 12%. Significantly slower than InMode. But a big reason why is their newer products are still overtaking sales of their older products. Their new products are growing fast, their legacy products are declining. That's the reason why the top line growth is relatively muted. But below the line, we saw that their gross margin took a step up 100 basis points to 51%. 21% of their revenue is now recurring in nature. That's very attractive for investors, and the company expects that that number is going to continue moving higher. Cutera was also recently able to generate a small profit, has a debt-free balance sheet. It's really a nice little business. But they are going to be competing eventually with InMode, which definitely has a differentiated solution that is clearly taking market share right now. But, Cutera definitely looks like a very interesting business for investors to get to know.

Jones: Yeah, absolutely. I mean, I think in this space, we've seen the competitive threats come and go. You've seen a lot of companies end up getting acquired or taken private. But I think this is one matchup you'll definitely want to keep your eyes on.

All right, so let's talk about the third company in the global aesthetics market. And that is none other than Sientra, and that's ticker symbol SIEN. Brian, when one typically thinks of this space, I think this is the type of company that most investors or even people in the public tend to think of. This is a company that's really made its bread and butter in the breast implant market. But what else can you tell us about this company in terms of what they do, and really their key products?

Feroldi: Yeah, so, Sientra -- for a sense of scale, this is about a $430 million market cap company. It's been in the market for many years. For a long time, they were solely focused on breast surgery products that were used for augmentation or reconstruction. However, within the last year or so, they launched into a brand-new market category in the aesthetics market with a launch of a product called miraDry. This is a non-surgical treatment for excessive underarm sweating. They created a product that uses thermal energy to eliminate sweat or odor glands under the armpit. This treats a condition called hyperhidrosis, which is actually very, very common. You're talking about 15 million Americans alone could potentially benefit from surgical intervention to eliminate sweat and odor glands.

Jones: That just shocks me, Brian. Sorry to interrupt you, but I didn't realize how massive a problem this actually is.

Feroldi: Yeah, it's bigger than you think, right? And that's just in the U.S., too. If you include the world, the numbers just skyrocket from there. So, that's been a very interesting launch for this company, which, again, has been dependent on breast surgery sales for years. That has certainly captured an investor's attention.

This is a company whose revenue recently grew 33% to $22.4 million, with about 50% sales mix between their miraDry and their breast products. Their gross margin is pretty strong at 67%. They are pursuing a razor and blade business model with the consumable portion having a 90% gross margin. In time, there is reason to believe that both sales and gross margin can increase.

On the flip side, the company is generating pretty significant net losses. Last quarter, their net loss was $22 million. They actually announced a corporate restructuring program to lower their costs and really refocus the business to increase efficiency.

They have a pretty good balance sheet, about $121 million in cash, $38 million in debt. When you talk about opportunity, in the U.S., they believe their breast products have an opportunity of about $700 million in annual sales, but their miraDry product, their estimate is $6.7 billion in annual sales. Now, that's, again, off of 15 million potential U.S. consumers, so that is probably an inflated number, but there's still room for this company to put up 20% top line growth for many years, I think.

Jones: Yeah, this is such an interesting company, especially with them having this new miraDry product line coming out. You've probably all seen and heard headlines with all the safety concerns surrounding breast implants. Sientra actually got a slap on the wrist from the FDA related to their silicone gel breast implants. Basically, the agency came out and said that they didn't do the post-approval study requirements that they were supposed to, basically evaluating the long-term performance of the implants and following the participants of the study annually for 10 years. Of course, Sientra came right out, issued a letter to physicians reinforcing that this is safe, but there's a lot of question marks just in this breast implants segment. So, I do like to see that they've got another opportunity moving forward that's a lot bigger than just the breast implants space.

But of course, now, Brian, now that we've talked about three companies, now's the time to ask, which one of the three is your favorite right now?

Feroldi: Well, I think that all three of these companies have interesting products in, obviously, a massive market. To me, it always comes down to, what's their valuation look like? What's their growth potential? And, what do their financials look like today?

Let's start with Sientra. They're trading for about 5 times sales. They're not yet profitable, but estimated 20% revenue growth. I would argue that they're the riskiest of any of these because their net loss is pretty substantial.

Then there's Cutera, which is 3 times sales. That's a pretty low multiple right there. But on the flip side, they're trading at 66 times next year's earnings estimates. But they're also estimated to grow their profits -- and they are profitable -- at 25% rate. So that's not extreme.

But then there's InMode. InMode is trading at 12 times sales, but only 32 times next year's earnings. Again, this company is just so profitable. And not only that. They're growing their revenue at 25%. So this is the rare situation where not only is InMode growing the fastest, but if you're using next year's earnings estimates, this is actually also the cheapest stock. So, that makes it a no-brainer for me to make that my favorite. How about you?

Jones: Yeah, absolutely, a no-brainer's a very good way to explain InMode right now. I mean, you've got double-digit top line growth, they're profitable, and with their platform, I still think lots of optionality, and that large international opportunity. I had a chance to sit down and chat with Bill Mann, who is a lead advisor for one of our global investing services, and he just talked about how big the aesthetic market in the Asia Pacific region is. Got really excited about it. So, for me, I think hands down, InMode is the clear winner of the three.

But, of course, there are more. So, I think, Brian, you and I need to come back to this segment, not only update on these three, but I think we should probably even add a few more to these as well.

Feroldi: Yeah, there are a number of companies to choose from. We didn't even touch on many of the bigger ones. These are more of the pure-plays. But, yeah, this is a big market and we have definitely not shown enough love on Industry Focus. Investors should get to know it.

Jones: Absolutely. We will be sure to follow up with that.

As for this week, that'll do it for Industry Focus: Healthcare. We want to thank you so much for tuning in. 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!