MMSI - Merit Medical: Reasonably-Priced Execution With M&A Upside

Summary

• Merit Medical delivered a modestly better than expected fourth quarter, with a little upside on revenue and a $0.02/share beat at the operating income line.
• Procedure normalization in areas like cardiology and electrophysiology should pull Merit along toward improved volumes in 2023.
• Growth drivers like an increased focus on innovative therapeutic products and M&A are still very relevant to the long-term thesis, but will take time to play out.
• Merit still looks undervalued below 4x forward sales.

Small cap interventional and diagnostic device manufacturer Merit Medical ( MMSI ) is never going to be among the more exciting names in med-tech, but that’s fine – a fine steady execution and share price performance to be plenty exciting, and Merit has continued to deliver on that. Merit’s modest mid-single-digit revenue growth prospects do carry the risk of the stock falling into the “med-tech no man’s land” that I’ve talked about in reference to AngioDynamics ( ANGO ) and Enovis ( ENOV ) in the past, but I do think there could be some M&A optionality here both as a buyer and a seller.

Up around 10% from my last article , Merit has outperformed the S&P 500 and the broader med-tech space by more than 20%. As I can argue for a share price closer to $80, there’s still enough upside here to merit a closer look, and I like the company’s leverage to both ongoing procedure volume recovery in the U.S. and growth in overseas markets.

A Modest Operating Beat To Close The Year

Merit’s fourth quarter results were okay. While the bottom-line beat of $0.12/share might suggest more than just "okay”, it was a lower-quality tax-driven beat and core operating results were closer to consensus than that bottom-line result would suggest. I’d also note that the magnitude of the revenue beat was smaller than it’s been for several quarters.

Revenue rose more than 8% in organic constant currency terms, beating by 1% after several quarters of 4% to 5% beats relative to the Street. The core Cardiology business grew almost 9% (Endoscopy was down more than 5%), with 16% growth in the OEM business, nearly 10% growth in the Cardiac business, and nearly 9% growth in Peripheral, while Custom Solutions was up about 2%.

U.S. sales rose about 5%, which looks about on par for core underlying growth in the med-tech space (based on the results reported by companies like Abbott ( ABT ), Johnson & Johnson ( JNJ ), and Medtronic ( MDT )), and I think those are relevant comps as much of Merit’s revenue comes from facilitating procedures (guidewires, sheaths, trays, catheters, and so on). OUS sales rose more than 12%, with China up high single-digits despite headwinds from value-based pricing.

Non-GAAP gross margin declined 60bp year over year but improved by more than a point from the prior quarter to 49.5%. Input cost and logistics inflation remain significant factors, though mix has helped offset this to some extent.

Operating income rose 8% (non-GAAP), which margin up 40bp yoy and 170bp qoq to 17.8%. Operating income beat by about $0.02/share, with the remainder of the EPS beat driven by a much lower tax rate.

Guidance for 2023 was consistent with Street expectations. Management guided to 5% to 6% revenue growth with a midpoint just above Street expectations. Likewise with margin and EPS guidance, with the midpoint of the EPS range ($2.845) just ahead of the prior sell-side average of $2.83 for 2023.

Leverage To Ongoing Normalization

As a “facilitator”, I do expect Merit to benefit from continued normalization in procedure volumes. Multiple companies targeting the cardiology space (Abbott, Boston Scientific ( BSX ), et al) are pointing to improving conditions for interventional cardiology and electrophysiology procedures, and hospitals are certainly motivated to get their cath labs running back to normal, as this is a “cash register” clinic for most facilities. That should in turn drive improved demand for a range of Merit products in the Peripheral, Cardiac, and Custom Solutions businesses.

I also continue to see good demand for neurovascular and peripheral procedures at Inari ( NARI ) and Penumbra ( PEN ), and Merit can participate there through its OEM business (which counts Inari and Penumbra among its customers).

Procedure volume normalization also applies to the oncology space, and Merit has done well here on the back of products like SCOUT for tumor localization. On that subject, I think it’s worth pointing out that the company received FDA Breakthrough Device designation for its new SCOUT MD surgical guidance system.

I don’t expect SCOUT MD to be a game-changing product for Merit, but I like what it says about the company’s ongoing commitment to innovation. As I’ve discussed before, Merit management is pivoting toward more proprietary therapeutic devices, and while this expansion requires elevated R&D and more time (clinical trials and so on), the rewards in terms of pricing power, volume growth, and margin/profit enhancement make it more than worthwhile.

I continue to believe that the company’s Wrapsody AV access prosthesis can be a meaningful driver for the company, and while commercialization is still likely two years or so away, I expect to see more product development along the lines of Wrapsody – novel solutions to clinical issues (in this case, AV fistula patency) that may not be big enough to attract the attention of the biggest players, but offer enough revenue to make it worth Merit’s time.

M&A Remains A Wild Card

Merit has lived up to its pledge to be more selective and prudent with M&A, but I do believe management would love to do some deals at the right price. Companies ranging from Abbott to AngioDynamics to Boston Scientific and Integra ( IART ) have shown that you can do meaningful deals for a sub-$100M price tag, and I think there are opportunities over the next few years to add meaningful revenue this way.

I could also see Merit as a seller. There have been rumors off and on of M&A interest in Merit, with most of those rumors pointing to private equity as potential buyers. The last such rumors were almost a year ago (at a low-$70’s price), but with a CEO not exactly a young man, I could see a transaction at the right price.

The Outlook

Given that I am a believer in products like Wrapsody and SCOUT MD being difference-makers for Merit, as well as management’s commitment to continue developing more innovative and/or disruptive new products, I’m confident with a modestly higher-than-average revenue outlook. I’m expecting long-term revenue growth around the 6% range, and my ’26 revenue estimate is about 5% above where the Street’s at now.

I expect ongoing margin improvement, with around 150bp/year of margin improvement over the next five years, taking non-GAAP operating margins into the low-20%’s. I do believe FCF margins could be abnormally high in the near term as working capital build reverses, but over the long term I expect improvement towards the mid-teens, driving high-single-digit normalized growth.

Discounted cash flow doesn’t really support a bullish thesis on Merit, but that’s more common than not for smaller med-techs. Using my growth and margin-driven multiple approach, I believe a 4x forward revenue multiple is still appropriate, and that supports a fair value a little above $80 based on my FY’23 revenue estimate.

The Bottom Line

As I’ve said before in reference to Merit and similar companies, sentiment remains a risk as slower-growing small med-techs often struggle to earn attractive multiples – I remember from my sell-side days talking to buy-side managers who wouldn’t even consider med-techs that didn’t have double-digit (sometimes 20%-plus) revenue growth rates.

Still, I think Merit is executing well and not fully valued on that basis, and this is a worthwhile name to consider for investors who can be happy with a less dynamic med-tech play that still has meaningful self-improvement potential.

To read my recent articles on Abbott, AngioDynamics, Boston Scientific, and Integra LifeSciences, please click here ( ABT ), here ( ANGO ), here ( BSX ), or here ( IART ).

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