C.R. Bard (NYSE:BCR) finds itself in an interesting and unfamiliar situation – for the first time in quite a while, the Street actually has relatively demanding growth expectations. Bard has long based its business upon strong share in lower-average selling price consumables-driven businesses that don't offer spectacular underlying growth. Now management is looking to deliver more growth, as it prepares to leverage its new Lutonix drug-coated balloon and acquisitions driven by the incoming cash from Gore's patent infringement damages.
Bard has indeed returned to a level of growth that hasn't been seen in years. As is so often the case, though, my concern now is with the expectations that are getting baked into the valuation. With today's valuation not leaving much (if any) margin of safety, I'd prefer other names in the med-tech space.
Good growth, but at a lower margin
Bard outperformed expectations for the fourth quarter, with constant currency growth of about 4% and organic growth of around 3%. On an organic/adjusted basis, all four business lines were positive on a year-over-year basis -- vascular up was up 2% (excluding the electrophysiology divestiture to Boston Scientific), urology was up 1%, oncology was up 5%, and surgical specialities was up 1%.
Margins were disappointing this time around, largely due to higher SG&A spending tied in part to the company's recent string of acquisitions and spending intended to help drive expected revenue growth. Gross margin was OK relative to expectations, although it declined from 62.3% to 60.7%.
Lutonix data weren't as expected
One of the recent controversial points on Bard is the future of the Lutonix drug-coated balloon (DCB) in the wake of LEVANT II data. This study showed good primary potency versus angioplasty (92.3% versus 82.7%) in SFA patients, but freedom from TLR at six months was basically equal (96%) between the two groups. That's a very surprising result, as most peripheral interventions (drug-coated stents, etc.) show an advantage at six months and DCBs were/are expected to be a significant step forward.
What is important to note is that Bard ran a particularly rigorous study. Normally "bailout stenting" (done when the angioplasty procedure dissects the vessel) is counted as part of TLR, but Bard excluded that. In addition, the doctors who evaluated the images at six months were blinded as to the treatment and control groups which generally favors the control.
I think the key opinion leaders will understand and appreciate these differences, but Bard likely still needs to show a meaningful separation between the Lutonix and angioplasty groups at 12 months for strong commercialization. I do believe that peripheral DCBs can be a $1 billion market, but pricing balloons on par with stents ($1,500 or so) could be tricky without a clear advantage at 12 months.
Bard is also still the leader in this emerging space. Medtronic (NYSE:MDT) is not far behind with its IN.PACT balloon, and Covidien (NYSE:COV.DL) is also intending to compete with a balloon of its own. So far it would seem the data favor Bard and the Lutonix, but the differences in trial design and endpoints make that more of an impression than a conclusion.
Either way, this is going to be a battleground and the stakes are well over a billion dollars a year in revenue. Covidien has a large peripheral franchise, complete with balloons, stents, and mechanical ablation devices to treat a range of blockages throughout the peripheral vasculature. Medtronic lacks the mechanical ablation offering (as does Bard), but competes with a range of stents and balloons. In such a competitive market, any advantages in potency, TLR, ease of use, or breadth of use (Medtronic's IN.PACT failed in a European study of below-the-knee usage) will be important for market share.
A year of digestion and integration
Bard management is going to be busy in 2014, as the company needs to integrate three deals (Rochester, Medafor, Loma Vista), keep the Lutonix program moving forward, manage ongoing pelvic mesh litigation, launch new products like the Fluency Plus stent graft, and keep an eye out for additional M&A targets. If they can execute on all of that without dropping the ball, 2015 should be the start of a good multi-year window of above-average growth and improved free cash flow generation.
The bottom line
My outlook for Bard is for long-term revenue growth around 4% and FCF growth around 7%, a level of above-average growth similar to my expectations for Covidien. Wall Street is valuing that growth potential at a higher multiple, though, and Bard does not look all that cheap on a discounted cash flow basis. Likewise, the implied EV/revenue multiple for 2014 is above 3.0 and on the high end for large-cap med-tech.
Consider the following table:
|EV / 2014 rev (est)||3.4||3.3||3.2|
|EV / TTM rev||3.6||3.4||3.3|
|EV / 2014 EBITDA (est)||11.9||12.1||8.5|
|EV / TTM EBITDA||13.2||12.4||9.8|
|* COV and MDT numbers adjusted for their different calendar years|
While analysts do expect more revenue growth from Bard than either Covidien or Medtronic, I believe that is already factored into the price. Taking that all into consideration, I think investors either need to have a firm conviction that Bard is going to deliver even better growth than expected, or they need to look at other names for better value today.