STAA - STAAR Surgical Company: Getting Ahead Of Itself In 2023

Summary

• Shares of implantable lens manufacturer STAAR Surgical Company fell over 55% beginning in August to close out 2022 as Covid lockdowns in China – its largest market – hurt badly.
• With ~95% of its revenue coming from outside the U.S., currency translations have also negatively impacted STAAR Surgical Company's top and bottom lines throughout 2022.
• However, STAAR Surgical Company stock has been on a roll in 2023, gaining more than 35% in the month of January.
• With secular tailwinds and a March 2022 FDA approval meaningfully expanding its domestic market opportunity, the recent beneficial owner buying merited further investigation.
• An investment analysis of STAAR Surgical Company follows in the paragraphs.

The face is a picture of the mind with the eyes as its interpreter ."? Marcus Tullius Cicero.

Today, we look at a medical device company that should benefit from China finally lifting their Covid lock downs after three long years. It should also be the beneficiary of a FDA approval last year, and its shares saw purchases in late December from a beneficial owner. After collapsing in the back half of 2022, the shares have gained more than 35% in the month of January to start 2023. Can the roll continue? An analysis follows in the paragraphs below.

Company Overview:

STAAR Surgical Company ( STAA ) is a Lake Forest, California-based developer of implantable lenses for the eye and their companion delivery systems. With over two million implantable Collamer lenses [ICL] sold since inception, it is the world's leading manufacturer of intraocular lenses (IOLs) for refractive error correction. STAAR was founded in 1982 with its first sale of publicly traded securities sale conducted at $13 a share in 1992. Shares of STAA trade just over $70.00 a share, translating to a market cap of approximately $3.3 billion.

Refractive Errors

There are four common types of refractive errors: nearsightedness (myopia), where far-away objects look blurry; farsightedness (hyperopia), where nearby objects look blurry; astigmatism, where both far-way and nearby objects look blurry; and presbyopia, where it is difficult for older individuals to see items close up. These disorders can be treated with eye glasses, contact lenses, or refractive surgery, the latter of which can be accomplished through LASIK or STAAR's ICLs.

STAAR's lenses are foldable, permitting minimally invasive implementation behind the iris and in front of the natural crystalline lenses, working with (as opposed to replacing) the latter to improve vision - a technique characterized as "phakic." They are composed of biocompatible collagen copolymers - thus the name Collamer - that are exclusive to STAAR. The outpatient procedure employing STAAR's ICLs is somewhat similar to cataract surgery - both only requiring topical anesthesia - but differs in that the latter removes and replaces the eye's natural lens. The company's posterior chamber phakic ICL is the only one of its kind approved by the FDA. First commercialized outside the U.S. in 1997 for myopia, STAAR's ICL models are also designed to correct hyperopia and astigmatism. They comprise over 90% of the company's top line with the soon-to-be-phased-out (YE23) lower margin cataract IOLs and delivery systems currently accounting for the balance.

Opportunity

The market for STAAR's ICLs is significant. With seemingly most of the world engrossed in their cell phones and laptops, more than two billion individuals currently suffer from myopia. That estimate is expected to rise to nearly five billion by 2050, with astigmatism accompanying approximately one-quarter of those cases. Furthermore, 75%-80% of people between the ages of 45 and 54 are already employing some form of corrective action for presbyopia. In dollar terms, ~$48 billion are spent globally on eyewear annually, followed by ~$16 billion for contact lenses. By contrast, the refractive surgery market is relatively small, with 4.2 million procedures performed worldwide in 2021, comprising a $6 billion market opportunity for STAAR. One of the chief obstacles to refractive surgery is that it is an elective procedure, costing about $3,000 to $5,000 per eye, and is generally not covered by insurers. That said, management estimates its total market opportunity at 35 million myopes (70 million eyes) and 55 million presbyopes.

Although certainly more invasive than eyewear or contacts, the ICLs restore 20/20 eyesight, significantly improve night vision, and provide UV protection without dry eye syndrome in a procedure that unlike LASIK - where corneal tissue is permanently removed - is reversible. However, LASIK is an extraocular procedure (i.e., less invasive than ICLs) and can be performed on both eyes simultaneously, whereas ICLs are typically implanted on separate days. That said, in a 2018 survey, 99.4% of patients receiving the ICL said they would elect the procedure again. Owing to this high patient satisfaction, STAAR has made notable inroads against LASIK in China (the world's number one refractive surgery market), growing its market share from 2% to 20% from 2015 to 2020.

It should be noted that STAAR does receive competition from Ophtec's iris clip anterior chamber posterior IOLs in certain geographies, but management believes its offerings are superior, citing its relatively dominant market share (vis-à-vis Ophtec) and its position as the only company with an FDA approval for a foldable ICL.

Backstory and Share Price Performance

Although STAAR Surgical Company's technology has been around for two and half decades and been implanted in more than one million individuals, the procedure has not always been as easy as advertised. Prior to 2011, surgeons employing STAAR's ICLs needed to perform a YAG peripheral iridotomy procedure a few days prior to implantation so the eye would drain properly post-surgery. [For the curious, YAG stands for yttrium aluminum garnet, which is a synthetic gemstone employed to generate a specific wavelength of light for a laser procedure.] The company developed a workaround with the introduction of central port in the center of the ICL optic to optimize fluid flow without affecting vision quality; thus, eliminating the need for the YAG procedure. This CentralFLOW technology has been further upgraded and is available in multiple ICLs treating different refractive errors in approximately 40 countries. However, it was not made available in the U.S. until March 2022 as STAAR had struggled to obtain FDA approval for three years.

However, with hopes of an FDA approval ever present and the world awash in pandemic stimulus, the company's sales surged 51% FY21 vs FY20 (to $230.5 million), driving shares of STAA 603% off their pandemic selloff lows to an all-time intraday high of $163.08 in September 2021. However, with multiple compression hitting the med tech group, its stock began a protracted decline. The March 2022 FDA approval provided a boost with shares of STAA still trading at $112.27 in August 2022 after a better than expected 2Q22 earnings report.

3Q22 Earnings & Outlook

However, with China accounting for approximately half of STAAR's sales and the U.S. only ~5%, the impacts of new Covid-19 lockdowns and a strong U.S. dollar cratered its stock over the subsequent five months. These issues were brought to light on the company's 3Q22 financial release on November 2, 2022.

It reported earnings of $0.21 a share ((GAAP)) on net sales of $76.0 million versus $0.12 a share ((GAAP)) on net sales of $58.4 million in 3Q21, representing 71% and 30% improvements, respectively. The bottom line significantly bested consensus of $0.13 while the top line was better by $1 million. Gross profit improved 190 basis points to 79.5%. On a non-GAAP basis (factoring out currency and stock-based compensation), STAAR reported $0.37 versus $0.21 in the prior year period, which was $0.16 better than expectations. These were continuations of favorable YTD22 trends, with the company earning $1.08 a share (non-GAAP) on revenue of $220.3 million versus $0.68 a share (non-GAAP) on revenue of $171.5 million, reflecting improvements of 59% and 29%, respectively.

Operationally, U.S. surgeons trained on its recently approved ICL were expected to reach or exceed 600 by YE22.

The problem for the company lied with its FY22 (really 4Q22) outlook, which was adjusted downward from $295 million to $285 million to account for harsh Covid restrictions in China and the strong dollar. Management put FY23 net sales at $355 million, representing a 30% increase.

Affirming what the market had been suggesting over the prior three months, STAAR's stock fell 15% in the subsequent trading session to $59.84 and traded sideways until the surprise "retirement" of CEO Caren Mason in mid-December 2022. Given her stellar seven-year record at the helm, the abrupt nature of her departure and the fact that the $355 million FY23 net sales estimate was not reiterated on the presser provided enough uncertainty for the market to drag shares of STAA under $50, which was down 57% from their August 2022 high and 70% from their all-time high.

Investor enthusiasm has reignited around the stock so far in 2023, with the shares up an impressive 37% in January to start the new year. This rally has occur despite the company ever so slightly lowering guidance on January 9th. Management now expects full year sales of $284 million in FY2022 as well as $340 million in revenue in FY2023.

Balance Sheet & Analyst Commentary

The to-date unknown circumstances surrounding her departure notwithstanding, Ms. Mason left the company in excellent financial stead, with cash and investments of $224.7 million and no debt.

A half dozen analyst firms including Needham and Jefferies have reiterated Buy/Outperform ratings on the stock over the past six weeks. Price targets proffered range from $65 to $90 a share.

The Street is expecting STAAR to earn $0.76 a share on a 23% rise in net sales to $284.5 million in FY22, followed by $.99 a share ((GAAP)) on net sales of $346 million in FY23.

Beneficial owner Broadwood Partners is not in accordance with Mr. Stephan's commentary, using the 52-week lows in STAAR stock as a buying opportunity, purchasing 191,075 shares at an average price of $47.42 in final three trading sessions of 2022.

Verdict:

There are four factors at play regarding STAAR Surgical Company's outlook. The first is its success (or lack thereof) against LASIK; the second are the overall prospects for the refractive surgery market; the third is the global macroeconomic backdrop; and the final is its current valuation given the first three factors. Mr. Stephan's survey of doctors notwithstanding, STAAR is clearly winning market share against LASIK in the Chinese market - the world's largest - with management indicating that its cut of the refractive surgery market could surpass 25% by YE22. Even though the macro backdrop is clearly weak, the market for people needing vision correction is massive and growing - enough so that this secular tailwind will not be sheared longer-term by lockdowns or a downturn in disposable income. That leaves valuation.

After a huge rally to start 2023, STAAR Surgical Company shares go for approximately 70 times forward earnings with approximately 20% sales growth in the cards for FY2023. STAAR Surgical Company is going to win over the long haul, but its current valuation in a high interest rate environment with a somewhat uncertain FY23 revenue outlook suggests a non-compelling risk-reward profile at current trading levels.

The tongue may hide the truth but the eyes-never! "? Mikhail Bulgakov.

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