EW - Edwards Lifesciences: Valuation Premium Earned But Shares Are Not Cheap Technicals Mixed

2023-06-12 13:42:19 ET

Summary

• Medical device stocks, including Edwards Lifesciences, have struggled in recent years, with EW's stock wavering amid uncertainty around its Transcatheter Aortic Valve Replacement procedure.
• Despite solid Q1 results and increased full-year sales guidance, risks remain regarding growth potential away from TAVR, leading to a hold rating on valuation.
• The technical picture is also mixed, with some recent weaknesses amid softer momentum.

Medical Device equities were a darling niche leading up to the pandemic. Relative strength in the iShares U.S. Medical Devices ETF ( IHI ) actually notched new all-time highs against the S&P 500 ETF ( SPY ) in Q2 2020. But the bears soon asserted pressure. The last three years have been a period of relative weakness for IHI.

Likewise, shares of Edwards Lifesciences ( EW ) have underperformed since early last year. Amid continued uncertainty from its Transcatheter Aortic Valve Replacement (TAVR) procedure that is used to replace damaged or diseased aortic valves with prosthetic valves, the stock has wavered lately after trending up earlier in the year. I reiterate my hold rating on valuation and technicals.

Medical Device Stocks Struggle Vs SPX

According to Bank of America Global Research, EW provides devices and technologies for structural heart disease, critical care, and surgical monitoring. The firm is a leader in transcatheter heart valve replacement - one of the most visible and innovative markets in the medical device sector.

The Irvine, California-based $51.0 billion market cap Health Care Equipment industry company within the Health Care sector trades at a high 35.0 trailing 12-month GAAP price-to-earnings ratio and does not pay a dividend, according to The Wall Street Journal.

EW reported a solid Q1 with EPS topping estimates modestly along with a small revenue beat. Helping to lift shares in the days following the report was a raising of its full-year sales guide. Revenue is now expected to climb by 10-12% compared with the previous range of 9-12%. TAVR sales are seen in the $3.8 billion to $4.0 billion range. The strong quarter came after some bearish comments from Wells Fargo regarding TAVR sales, so the quarter was a relief for the bulls. Still, risks remain about growth potential away from TAVR, so the concentration there is cause for some worry.

On valuation , analysts at BofA see earnings rising modestly this year after two stellar years of bottom-line growth. Per-share profits are then expected to resume to the low-double-digit growth rate in the out year and 2025. The Bloomberg consensus forecast is about in line with what BofA sees. Even with positive free cash flow and very strong profitability , no dividends are forecast to be doled out.

EW: Earnings, Valuation, Free Cash Flow Forecasts

The stock has rallied in the last few quarters, leaving the valuation still somewhat elevated. With a forward operating P/E near 35 - above the sector median of 28.3 - the PEG is above 4.0. That is higher than EW's 5-year average, and even if we assume a 12% growth rate of EPS, then the PEG is near 3.0 - right near the long-term mean.

With a price-to-sales ratio of 8.5, the stock is not a steal, and while growth is decent, but not high enough to warrant a buy rating. I would like to buy EW closer to the sector average P/E of 28 - which would be in the mid-$70s based on next-12-month EPS. Hence, I am a hold on valuation.

EW: Expensive On the Surface, But Strong EPS Growth Is An Offset

Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q2 2023 earnings date of Thursday, July 27. The calendar is light on volatility catalysts until the reporting date.

Corporate Event Risk Calendar

The Options Angle

Digging into the upcoming earnings report, data from Options Research & Technology Services (ORATS) show a consensus EPS forecast of $0.65 which would be just a 3% increase from $0.63 of per-share earnings in the same quarter a year ago. The company has a mixed beat rate history, while shares have traded lower post-earnings in six of the past seven reports, so the trend is not all that encouraging.

For the July release, the options market has priced in a small 4.0% earnings-related stock price swing when analyzing the at-the-money straddle, expiring soonest after the Q2 report. While EW moved less than 1% post-earnings last time, I am inclined to go long that premium on this medical device name. Large price changes were seen in 2022 through the report this past January.

EW: Low EPS Growth YoY Seen, Cheap Options

The Technical Take

EW has been trending higher since notching a low last November. I had highlighted potential support near $66 after the massive October plunge, and that proved to be a reasonable outlook. Notice in the chart below that the stock has put in a series of higher highs and higher lows (for the most part) in the last seven months. What's more, the short-term 50-day moving average has crossed above the long-term 200-day moving average in what technicians deem a golden cross.

But the chart does not shine everywhere. I see that the RSI momentum index at the top of the graphs exhibits a bearish divergence with price action. So, we are in a near-term corrective period, but I see support in the low $80s near the 200-day. There's modest resistance in the $88 to $90 range.

Overall, it's an improved chart, but the bulls still have work to do.

EW: Bullish Break Above the 200-Day, Bearish RSI Divergence

The Bottom Line

I reiterate my hold rating on EW. The valuation is not particularly cheap despite the solid growth picture. Technicals, meanwhile, are neutral to slightly bullish ahead of July earnings.

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