Diversified large cap med-tech Boston Scientific (NYSE:BSX) has made meaningful progress in cleaning up its act, and the Street has returned to the stock in force, pushing the stock up almost 70% over the past year and over 100% over the past two years. That sort of performance has left rivals like Medtronic (NYSE:MDT), Abbott Labs (NYSE:ABT), and St. Jude Medical (NYSE:STJ) well in the dust, but now it's time to deliver. Can Boston Scientific actually produce the growth and margin improvements that have underpinned so much of this optimism?
Fourth quarter results just OK
Boston Scientific's fourth quarter results serve to underline that issue for me – the results were OK, but I don't think "OK" is enough to validate a significantly higher stock price from here.
Revenue rose about 3% in organic terms, with decent results in CRM and good results in surgical offsetting weaker performance in cardiology. Margins were more disappointing. Gross margin improved more than half a point from last year, but missed the average sell-side target by half a point, while higher SG&A spending ballooned the miss on the operating margin line to more than a point. An unexpectedly low tax rate saved the company's bacon when it came to analyst EPS estimates.
CRM should get interesting
Seeing that St. Jude Medical reported almost 6% growth in its CRM business for the fourth quarter, Boston Scientific's 3% growth has to be considered a modest disappointment. Medtronic has yet to report, but unless there's a pretty stunning market share shift away from Medtronic, it looks like Boston Scientific continues to leak market share in CRM overall. More concerning were the weak margins from this quarter, as Medtronic and St. Jude are considerably more profitable in their CRM businesses.
I'm looking for 2014 to be a better year. First of all, it looks like procedure volumes are improving all around, and that's a rising tide that should lift all of these boats. Second, Boston Scientific is no longer capacity-constrained with its (relatively) new S-ICD product. I think it will take some time for this product to really catch on, but it should be a positive factor in the ICD business and getting past costs tied to the launch and supply improvements ought to help margins. Still, I remain a little concerned that Boston Scientific really couldn't pounce on St. Jude's lead issues and gain meaningful share from them in 2013.
Will stents stop hurting?
With every quarter, Johnson & Johnson's decision to get out of the coronary stent market seems like a wise move. Coronary stents have become an intensely competitive market with not all that much underlying growth anymore. Boston Scientific has lost about seven full points of market share to Abbott and Medtronic over the past two years, and the 10% decline in revenue from drug eluting stents this quarter is depressing. Making matters worse, Abbott's Absorb bioresorbable stent looks like the real deal, with solid improvements in angina versus Xience in a small Italian study.
Hopefully the share losses won't get much worse. There's still some value to this business, as it gives Boston Scientific a larger overall presence in cardiology that can be useful when it comes to launching new products and bundling (an area where Abbott is comparatively weaker, particularly in structural cardiology). Even so, I have to wonder about the R&D commitments necessary to keep this business moving forward.
Other segments doing better
Boston Scientific reported Watchman sales that were a little disappointing, but it's still much too early to be all that concerned (though the real market opportunity is a subject of some debate). As a reminder, St. Jude Medical recently stopped its pivotal study for the competing Amplatzer product to redesign it as a non-inferiority study versus Watchman, due in part to worries about enrolling patients in the wake of Watchman approval.
Other products/lines did pretty well, though. Neuromodulation was up more than 30% and the company has definitely been outrunning St. Jude lately. Endoscopy sales were up 8% on strong growth in Alair, and this product is really only getting started. All told, while the Street seems pretty obsessed with Boston Scientific's CRM business in general (and the S-ICD product in particular), there are some good things going in neuromodulation, endoscopy, and uro/gyn – businesses which, combined, are only 15% smaller than CRM.
The bottom line
There aren't many obvious bargains left in this sector anymore, and Boston Scientific doesn't seem to be among them. Even high single-digit free cash flow growth (near 9%) can't support a price near $12 unless you choose to just ignore the net debt. Using the looser (and relatively popular) standard of EV/revenue, a 2.5x multiple to 2014 estimated revenue supports a price above $16.
Boston Scientific is definitely a more diversified company today, with multiple opportunities for growth in the coming years. I just don't think the shares are exceptionally cheap, as management still needs to deliver some hefty margin improvements just to catch up with rivals like Abbott, Medtronic, and St. Jude Medical.