TFX - Teleflex Already Getting A Pretty Good Benefit Of The Doubt

Summary

• Teleflex goes into 2023 needing to prove to the Street that its 15% growth target for UroLift is still viable after multiple recent disappointments in sales growth.
• M&A could accelerate from here as the company has around $2B in deployable capital and a good track record of post-deal execution.
• Teleflex already has solid margins and management has credible plans in place to drive further leverage over the next few years.
• A reacceleration in UroLift revenue would be a big positive for the shares, but I don't see a compelling buy argument today without better evidence of UroLift reacceleration.

Teleflex ( TFX ) goes into 2023 needing to prove that the company can get the business growing back to a level more in line with investor expectations, and that includes the key UroLift product. The company has faced challenges including disrupted office visit trends and supply shortages, but the market is not going to be particularly forgiving if the business doesn’t start showing real acceleration over the next few quarters.

I can’t say that I’m all that bullish on the shares today. I think reaccelerating the UroLift business may be more challenging than management believes, and I’m concerned that the company is going to find itself challenged to meet Street growth expectations. M&A remains a wild card, and management has a good track record here, but I just don’t see the combination of growth and margins that would lead me to get all that excited about today’s valuation.

The Challenges With UroLift May Be More Than Just Temporary

Accounting for what I believe is close to 10% of the company’s revenue, UroLift is a key part of the Teleflex story, but this office-based interventional treatment for enlarged prostate (benign prostatic hyperplasia, or BPH) has been underwhelming of late, with a series of below-expectation quarters. In the third quarter of this year, not only did UroLift come up short of management’s guidance for sequential growth, but the underperformance of the business shaved almost two points off of the company’s organic growth rate.

Management believes that the challenges here are temporary, and that the main problem is that patient visits to doctors for BPH are still well below pre-pandemic levels and that procedures are being delayed because of staffing issues. Moreover, management still believes that this is a product that can grow 15% a year for several more years, particularly with recent launches in Japan and China.

I’m more cautious. Listening to other companies in the space and looking at surveys of physicians, I’m not seeing much support for the idea that urology visits are down by the 20% or so that Teleflex management has suggested. While I’m sure staffing shortages are playing some role, I’m concerned that PROCEPT BioRobotics ( PRCT ) may be gaining enough traction with its robotic Aquablation system to impact Teleflex’s results.

I’m not going to get into the respective advantages and disadvantages of the two systems here, and UroLift is still significantly larger than Aquablation (so, Aquablation’s numbers need to be seen in the context of building off a smaller base), but Procept just announced preliminary fourth quarter revenue growth of over 130%, with handpieces and consumables up more than 200%, and this is in an environment where there’s still some pressure on capital equipment (Procept announced roughly 100% growth in system revenue) and training personnel on new equipment.

I don’t believe that UroLift is doomed. Launching the product in Japan puts another $2B or so into the total addressable market, and the UroLift system still has leading share in the market (in the neighborhood of one-third, I believe). But in the context of the company struggling to meet/beat growth expectations, I do worry that management may have to reduce guidance again if there isn’t a meaningful acceleration in 2023.

Normalization Should Help, But M&A May Be More Front And Center

UroLift wasn’t the only part of the business to see challenges in 2022. Like many companies, Teleflex saw significant negative pressures from supply chain challenges (including higher costs and limited availability) and freight costs. Freight costs have gotten better, but are still elevated. Likewise, supplies of Tyvek, used to wrap kits and trays, has started to improve and should continue to do so throughout 2023.

One of my concerns about Teleflex is that the company’s mix of products could make growth more challenging. While there are interesting growth products like UroLift (hopefully), the Arrow EZ-IO intraosseous access device, MANTA closure devices, and the recently-acquired Titan SGS stapler (for bariatric surgery), I’m worried about the drag from slower-growing legacy products. Teleflex’s high-growth portfolio grew 14% in the third quarter against overall organic growth of 2.4%, and management could use a few more growth drivers.

I would expect M&A to feature significantly in those plans. The company has been an active acquirer over the years and has generally done a good job of identifying promising products and executing after the deal. With $2 billion of deployable capital, I believe the company could acquire something in the neighborhood of $200M to $300M in faster-growing med-tech assets over the next year or two.

The Outlook

Teleflex management has guided to 6% to 7% growth over the next few years, but I think they’ll be hard-pressed to deliver on that target, and I think it will be hard to meaningfully surpass 5% annual revenue growth without M&A activity. I’m more bullish on the margin outlook, though, as the company has executed relatively well here in the past and has operating margins that are on par (but not superior to) with better-run larger med-tech companies.

I do expect EBITDA margins to improve back above 30% in FY’23 and I think there could be a couple years of 100bp acceleration beyond that. That should help drive a 20%-plus free cash flow margin, and I think mid-to-high single-digit FCF growth is achievable. Were UroLift to reaccelerate back to management’s target level there would definitely be some upside to these numbers .

As is, the valuation doesn’t really work for me. I don’t see the shares as attractively-priced on discounted cash flow, and nor do I think the shares are any particular bargain on an EV/revenue business considering the company’s margins and revenue growth. While I know some sell-side analysts have pointed out that the company has been trading at a discount to other large-cap med-techs (versus an historical premium), I think that discount looks appropriate given where the company’s revenue growth and margin performance is today.

The Bottom Line

Teleflex shares have outperformed recently, and I think that has been driven by investors seeing that valuation gap with other med-techs and perceiving the shares as a relative bargain. It may also be the case that investors believe that we’ve already seen the worst in terms of UroLift disappointments and that growth will reaccelerate in 2023. I’d certainly like to see that happen, but as things stand today I can’t really say that I find this a compelling name.

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