CNMD - Conmed: Updated Guidance Is Positive

2023-05-19 15:06:38 ET

Summary

• Management raised their revenue forecast for FY23, primarily due to stronger-than-anticipated growth from acquisitions and projected increase in gross margins.
• Positive developments in General Surgery, enhanced staffing, and the successful resolution of the backlog have supported CNMD's performance.
• My revised model based on consensus updated figures and an average forward PE multiple suggests attractive upside.

Description

Conmed ( CNMD ) stock price performed just as expected, inching closer to my price target of $142 previously . The key driver to this performance is the better-than-expected 1Q23 results and positive growth outlook, of which 1Q23 strong growth was primarily driven by the swift recovery from the warehouse system disruption. Importantly, the growth strength was broad based with the recent acquisition also contributing. All of these drove a 10% EPS beat vs consensus ($0.66 vs $0.60). As for revised guidance, management pushed it upwards, reflecting recovering share dynamics following the disruption early in the year and improvements in procedure volumes and staffing. I believe the combination of these factors and a strong guidance will continue to push share price higher. As such, I reiterate my buy rating.

Guidance revised upwards

The strong reaction in the share price was, in my opinion, largely due to the revised guidance. Management raised their revenue forecast for FY23 by 3% to a range of $1.205 to 1.25 billion, largely due to the stronger-than-anticipated growth of In2Bones and Biorez in 1Q23. I was particularly interested in the projected increase in gross margins because it reinforces my view that earnings will grow faster than the topline. Gross margins are expected to land between 55.5% and 55.8% for FY23, then rise by 150 basis points in FY24 and 250 basis points in FY25, reaching close to 60% by FY25 (4Q22). This tells me that there is a plan in the works for the company to expand its offerings to focus more high-profit items. EPS is forecasted to rise to a range of $3.30–$3.50, from $3.20–$3.45 previously, thanks to the robust top line and gross margin improvement.

Backlog

The $30 million order backlog in 4Q22 due to a warehouse software issue was largely digested, contributing to the strong revenue performance in 1Q23. This backlog "benefit" is highly improbable to occur again, as CNMD is not the type of company that typically experiences backlog. Currently, backlog has returned to normalized levels. I think what’s interesting here is that the warehouse software issue did not disrupt the demand flow for CNMD, which means customers that might have purchased from competitors in 4Q22 came back for CNMD. This speaks of CNMD customers loyalty and also now that everything is back to normal, I expect growth to continue and the business to hit guidance comfortably. That said, I note that 1Q23 had another extra selling day which contributed around 100 to 150bps to growth, and this will have some negative comp headwind in 2Q23 sequentially.

Growth and acquisitions

In 1Q23, the overall positive performance was predominantly driven by favorable developments observed in General Surgery. This upswing was primarily attributable to notable enhancements in staffing and the alleviation of supply constraints. These advancements further compounded the positive impact derived from the successful resolution of the $30 million backlog, and encouraging growth trends witnessed in smoke evacuation, which experienced a robust increase of 20%. Since there do not appear to be any imminent constraints to growth, I anticipate these trends to continue. As I mentioned earlier, CNMD customer loyalty appears to be high, and as of 1Q23 half of customers who switched during the disruption have returned, and any remaining recapture is expected to take place over the next few quarters. However, it's important to note that not all customers will come back (since the disruption must have upset some customers significantly. Management's success in identifying and integrating strategic acquisitions is also highlighted by the most recent quarter. CNMD's four acquisitions now account for more than 30 percent of total revenue and are rapidly expanding and accretive to gross margin bottom line. Despite the absence of specific details regarding the future growth of AirSeal and Buffalo provided by management, my expectations remains that the business will continue to expand at a fast pace. This expectation is particularly reinforced by the recent passage of smoke legislation in 11 states (1Q23 earnings call), which is likely to contribute significantly to the business's growth trajectory.

Valuation

I updated my model (using consensus figures) in response to the revised guidance and outlook. My only deviation from the current market is valuation, which I expect to return to average eventually. However, I believe multiples will remain elevated in the near term due to the positive momentum. With my updated figures, my FY24 target price has risen to $162, representing a 40% increase.

Summary

CNMD has performed as expected, with the stock price nearing the previously set target of $142. The better-than-expected 1Q23 results and positive growth outlook, driven by the swift recovery from a warehouse system disruption and broad-based growth, led to a 10% EPS beat. Management's upward revision of guidance, reflecting recovering share dynamics, procedure volumes, and staffing, has contributed to the strong reaction in the share price. The resolution of the $30 million backlog and the company's customer loyalty indicate a favorable outlook for continued growth and the ability to meet guidance comfortably.

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