Summary
- I think MMSI has further upside versus consensus at the top and bottom lines.
- Return on capital continues curling higher, generating economic value.
- Valuations are supportive of a further re-rating.
- Reiterate buy.
Investment Summary
Merit Medical Systems, Inc ( MMSI ) posted its Q4 and full-year FY22 results recently with meaningful upsides on its longer-term averages, and growth that came in above consensus estimates. In my last MMSI publication, titled " Re-Rate to Buy, Upside Potential On Offer" I explained several reasons why the stock had attracted a more positive buy rating. In particular, the company continues to realize economic profitability by generating a consistent return on invested capital above the hurdle rate, and valuations are supportive of a further re-rating to the upside. Here I'll run through the moving parts in MMSI's FY22 earnings and give further insights in to the depths of its profitability looking ahead. Net-net, there's sufficient evidence that MMSI can continue generating future value for shareholders, with improving bottom-line fundamentals driving the upside. Reiterate buy.
Before that, you can see the last 4 MMSI publications here:
- Valuation And Performance Heavily Tied To ROIC
- 12% Downside Yet To Be Priced In Amid Flatlining Fundamentals
- No Change To Hold Thesis, ROIC Still One To Watch
- Re-Rate To Buy, Upside Potential On Offer
MMSI FY22 financials deep dive
Turning straight to the numbers, the company recorded total revenue of $1.15Bn, representing a YoY increase of 9.3% growth in constant currency ("cc.") terms. Gross profit also increased 600bps YoY, reaching approximately $561mm, which equated to a margin of 48.8% of sales, down ~50bps from 49.3% in FY21. Also noteworthy, management said it faced an incremental headwind of ~240bps to gross margin from inflationary pressures in 1) raw materials; and 2) freight and logistics. Looking to the outcome of its FFG program, I'd point out a reasonable and noticeable amount of operating leverage, as operating profit curled up by ~13% YoY to $195.1mm on a 17% margin, a decompression of ~100bps YoY. Moving down the P&L, it pulled this to earnings growth of 14% YoY to $155.8mm, or $2.70 per share.
Fig. (1)
Switching to MMSI's balance sheet, it left the year with cash & equivalents of $58.4mm, with total debt obligations of ~$198mm. On these figures, it had total available liquidity through accessible debt facilities of ~$523mm. This compares to cash on hand of $67.8mm and a total debt load of ~$243mm the year prior. Net leverage came in at 0.6x with the adjustments from year to year. Looking at changes to its invested capital in greater detail, I'd note the company has pared back the level of capital investment since FY19 [Figure 2], yet, the return on its capital has continued to shift higher. This feeds into the investment debate heavily and suggests the company has a robust profitability springboard to work from in driving investment into future growth, and the return it looks to see on said investment.
Fig. (2)
Regarding delta in cash flow, MMSI clipped a free cash inflow of $15.5mm in Q4. This translated to $69mm of FCF to the firm during the 12 months, below the company's internal target of $75mm. Management boiled this down to higher cash taxes, and changes in working capital secondary to a greater cash spend on inventory to sure up inventory and product supply to meet customer demand, given the supply chain challenges experienced during the last 12–24 months. As it relates to the point on ROIC above, the company has generated a growth in NOPAT of $73.4mm in annual NOPAT since FY17, on a $411mm increase in capital investment, otherwise, 70% of the $587mm in cumulative NOPAT generated over this time. As such, the incremental ROIC comes to 17.85% on this, meaning the company grew at a rate of ~12.5% over this period. Hence, the fluctuations in FCF have been matched with a corresponding uptick in ROIC, thereby suggesting the cash was invested wisely at a reasonable rate of return. This is something investors should be happy with, and more than covers the internal miss in FCF, as we are likely to realize this into future periods, by my estimation.
Fig. (3)
Growth drivers looking down the line
I'd note that MMSI's WAVE study covering its the WRAPSODY segment has been advancing. The study is assessing the investigational device for the treatment of stenosis or occlusion within dialysis outflow circuits. So far, 42 clinical sites have been actively enrolling patients. The company is targeting full enrolment of the first patient cohort by the end of Q3 this year. Moreover, the WRAP study is underway as well, with 27 sites selected in 10 countries – half of which have already been enrolling patients. The WRAP study aims to evaluate the clinical benefits associated with the use of WRAPSODY cell-impermeable endoprosthesis in patients receiving haemodialysis, whom are candidates for dialysis. Additionally, the StreamLock study is progressing towards a start-up phase in the coming months. It is examining the utility of the SCOUT surgical guidance system in Canada, in diagnosing and treating breast cancer. Finally, the company has four sites enrolling patients in a prospective observational study of its EmboCube embolization gelatin used to control bleeding or hemorrhage. It will enroll 100 patients across multiple centers in Australia and France.
Looking to FY23 guidance, I'd highlight these key points for investors:
- Management expects net revenue growth of approximately 4%–5% YoY baking a FX headwind of ~$10mm–$11mm. Looking at this in greater detail, it projects ~3%–5% upside in the cardiovascular segment and a growth range of ~14%–16% in the endoscopy segment.
- Looking out to its profitability guidance, MMSI expects GAAP earnings in the range of ~$105mm at the upper end, coming to ~$1.80 per diluted share. On an adj. basis, it looks for $168mm at the bottom line or $2.89 diluted EPS. This bakes in a gross margin range of approximately 50.4%–51%, and adj. operating margin of ~18.2%.
- Additionally, the expected CapEx range of $55mm to $60mm and FCF of ~$115mm are important metrics to consider in the investment debate as well.
Valuation and conclusion
The stock is trading at a premium and I'm of the opinion that it should catch a further bid in FY23 given it trades at ~27x forward P/E, a 37% premium to the industry. Investors therefore are pricing in a strong performance from the company this year. It is also priced at ~21x forward EBITDA, and this looks to be a challenge in the investment debate. I am aligned with management's forecasts of $2.89 in adj. EPS for this year, reflected in my previous MMSI update. Hence, at ~27x forward earnings, at the $2.89 forecast this sets a medium-term price target of $78, supporting the buy thesis.
Net-net, there's sufficient evidence from MMSI's FY22 numbers to suggest it's growth route is on a strong trajectory looking ahead. For FY23, I am eyeing further growth in its bottom-line fundamentals, with a resilient performance looking out the coming 12 months. Therefore, I reiterate MMSI as a buy.
For further details see:
Merit Medical: Still Bullish On Long-Term Prospects After FY22 Numbers