EW - Edwards Lifesciences: Catalysts For 2023 And Beyond

Summary

• Down 40%+ this year, EW is now trading at levels not seen in years.
• I believe the sell-off is unjust, and investors over the next few months will benefit immensely.
• This article will cover why past performance almost guarantees continued success.

Introduction

With a cursory look, Edwards Lifesciences (EW) just looks like an expensive, slow growth medical device company. 'Yes, performance over the past decade or so has been great, but surely that is just due to overvaluation', some may ask. I would care to disagree. At current valuations due to temporary headwinds, I believe that Edwards offers a great long-term investment.

In fact, I believe that Edwards is one of the only viable medical device companies on the market and will continue to outperform peers. This article will cover the major short-term catalysts that will allow for outperformance over the next few years.

No Stagnant Product Lines

For those unfamiliar, Edwards is a company focused on cardiovascular devices, particularly heart valve replacements. The major revenue segment relies on the company's market leading transcatheter aortic valve replacement (TAVR) technology. This non-surgical procedure has been the major cash cow of EW for almost the past two decades. Recent segment expansions include transcatheter mitral and tricuspid valve replacements, heart monitoring tech, and surgical versions of the heart valves.

One of the most important factors that decide whether a company stagnates or not is based on the product lines. Edwards is not a young company, but over 50% of revenues remain based on products released over the past five years. The company is also not stopping there as all revenue segments have clinical trials and improvements in the works to allow for sustained growth. In 2022 alone, four new regulatory approvals allow for expanded sales in the US and abroad. Then, the large clinical trial pipeline will allow for continued expansions for years to come.

Temporary issues such as staffing issues in hospitals that have pushed back elective procedures has done little to halt innovation at EW. As I will discuss later, the company is actually at a peak in profitability over the past few years and this is the key driving force behind the continued R&D focus.

With Profits Come Innovation

Due to the quality revenue segments, Edwards has become extremely profitable (think net income margins above 20%). Revenues have also grown at around 10% per year for some time. This has generated tremendous amounts of cash that have been reinvested into R&D. I could write a master's thesis on the opportunity, but the general idea can be summarized in a few ways.

• First, transaortic valves are primarily used only in severe patients so clinical trials collecting data on the safety and efficacy in moderate patients is occurring.

• Also, trials collecting data across different diseases of the heart allow for expanded indications, along with all new targeted devices.

• Lastly, long-term trials on the safety and efficacy of treated patients allows for transparency and improvements of the current devices, increasing utilization compared to peers.

All of these factors combined should allow EW to maintain revenue growth at the 10% long-term rate. The company also is not on bolt-on acquisitions, so most of the growth is purely organic. This highlights the large total available market and general opportunity present. In fact, one of the major catalysts for growth in the long-term revolves around market penetration.

Unfortunate Prevalence and Lack Treatment

According to a study in the Journal of the American College of Cardiology , the prevalence of cardiovascular diseases is only set to rise. There are many factors behind this including obesity and aging populations, but no researchers expect these factors to be brought under control. As such, the TAM for all EW cardiovascular solutions is set to grow. Another issue is the fact that many of EW's segments are leading in market share, but total TAM penetration remains low. Many suffering from cardiovascular disease do not seek treatment before it is too late, or elect other procedures such as anticoagulant drugs.

As EW continues innovating and improving their technologies, secular growth of market penetration along with the TAM will allow for organic growth to remain elevated. No other medical device company of equal size offers this much opportunity due to EW's focus on cardiovascular disease (DexCom ( DXCM ) in diabetes is close, but faces more competition). Therefore, temporary weakness due to labor and outside influences is a prime reason to invest.

Historical Performance

While significant innovation should be a key indicator of solid financial performance, I will summarize the historical financial data. As discussed, revenue growth has been steady at a 10% annualized rate since the early 2000s introduction of the TAVR technology. However, the pandemic has caused growth to stall as elective procedures become less frequent. Now in 2022 we are facing labor shortages and continued infectious disease impacts, even as COVID impacts seem to be dissipating. It is not like the impact is huge, as revenues are still growing around 7-10% per quarter. I expect growth to remain averaging 10-11% overall for at least the next five to ten years.

The chart below also highlights the significant improvements to profitability that has occurred over the past decade. While always quite profitable, earnings growth has surpassed revenue growth over the past decade. With the EBITDA and Net Income margins at ~35% and ~25%, respectively, earnings growth may subside over the coming years. However, the huge amounts of profits being generated and reinvested will support my revenue growth expectations. Plus, there may be some cash left over to continue benefiting investors as well.

Along with billions being spent on R&D, EW continues to have an extremely healthy balance sheet. Cash on hand has been increasing since 2019, and debt has remained flat. Total cash now outweighs debt at a 3:1 ratio. The positive cash flows have allowed EW to purchase back over 100 million shares over the past two decades, further stimulating earnings growth. There is very little in terms of historical data to suggest that Edwards has any financial weaknesses. The investor's problem then falls on valuation.

Valuation Clearly Suggests Upside

Thankfully, after a period of overvaluation, EW has now fallen into buy territory. While certainly not a company that needs to be traded due to volatility, taking heed of the valuation is important. Especially with the 40% decline over the past year. While I did not expect the decline to be this significant, I can now clearly state that EW is a strong buy at current levels. This is because we know that the financials are far improved over other periods in the past, and there are many catalysts to support continued rapid growth.

Just looking at the current valuation, we can see that EW is trading around levels last seen in 2018 or 2012. During both of those periods, leverage was higher, growth was weaker, and profitability was lower. Therefore, the common principles would suggest that the valuation is now low. The problem is that downward momentum remains strong and a few short-term headwinds may continue to suppress the valuation.

Conclusion

Despite the strong financial performance, all companies are at the whim of macroeconomics and investor sentiment. One key reason I believe EW may continue to fall over the next few months is the fact that the dollar remains strong, and EW has sales around the world. This will cause a temporary decline in revenue growth on a constant currency basis that investors may use to claim overvaluation. I also agree that buying while the dollar is strong is not advantageous, as current trends suggest the USD is weakening over the past few weeks. If the economy continues to weaken due to the high interest rate environment, then the USD will continue to fall.

Therefore, while on a historical basis Edwards Lifesciences is a strong buy opportunity, I would space out my investments slightly to account for a strong dollar. I believe initiating or adding to a position on a biweekly basis over the next quarter may allow for cost averaging around lows. I would be sure to revisit exchange rates and company growth at that point. In particular, investors may be right in predicting a major temporary slowdown in growth due to lowered surgical demand, and this may lead to further downside. I will certainly continue taking advantage of any further downside.

Thanks for reading. Feel free to share your thoughts below.

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