A clear trend has emerged in the health care sector. Large
companies are having an awfully hard time finding ways to grow. As
an example, I recently took a look at the dimming outlook for
In that column, I added that, "it's been a great era to invest in
smaller medical device companies." These firms (which should be
widened to include the companies in the field of health care
diagnostics) seem better equipped to move nimbly in new markets,
and some have proven to be attractive
candidates. Well, I've been tracking three companies that I think
make great investments -- with or without a buyout. All three are
expected to boost sales around +20% to +30% both this year and
next, and all three are well off of their highs seen a few years
eResearch Technology (Nasdaq: ERES)
I first took a deep look at this company, which helps test the
cardiac side effects on new, un-tested drugs, back in May after it
had made a smart acquisition in the respiratory monitoring space.
Big Pharma's Best Friend is about to Get Bigger
Shares have been flat since then, but quarterly results have surely
been impressive. The company surged past forecasts in the June
quarter, thanks in part to the newly-acquired respiratory division.
As a result, earnings estimates have been raised for both 2010 and
2011. Most importantly, I think analysts are still underestimating
all of the benefits of this deal, and I expect 2011 profit
forecasts to rise higher in coming months.
The key to that bullish outlook is a swelling
. Both of eResearch's divisions are bringing in new business at a
fast pace, and the company's recent
was 1.5, which means that for every dollar in sales the company had
in the June quarter, it secured $1.50 in new contracts. Backlog now
stands at $300 million, which implies that the company should have
little trouble matching estimates through 2011. And as new
contracts come in, the 2012 slate is filling up as well.
Demand is so strong because of changes at the Food & Drug
Administration (FDA). An increasing number of drugs have been
rejected for insufficient analysis of side effects, known as
toxicity. By using eResearch's software and hardware in the testing
process, drug companies can provide a much deeper set of data for
regulators to analyze.
I expect shares to move toward the $11 mark during the next year,
which translates into 20 times next year's likely profits. That
represents a solid +40% upside from current
NuVasive (Nasdaq: NUVA)
When a stock on my watch list sells off, I look at the reasons why.
If events have led me to change my long-term view of a company,
then I take it off of my watch list. But if the factors behind a
stock drop are part of my investment thesis, then shares can be
considered even more appealing. That's the story behind NuVasive,
which has lost about a third of its value since March due to
expectations of slowing growth.
On Tuesday, NuVasive cautioned that sales are only likely to grow
+15% to +20% this year, which is in sync with what some more
bearish investors had expected. Even as the company laid out that
new slightly lower growth target, shares barely budged as investors
now view forecasts to be more realistic.
Nuvasive sells a set of products to make back surgery a far less
onerous experience. And the medical community has quickly warmed to
the company's devices. Even as the overall spinal surgery market
has been growing at a slow pace, NuVasive's sales have risen at
least +48% in each of the past eight years.
Nuvasive's gear, which provides surgeons with more than 50 tools to
operate more delicately and quickly, allows doctors to make a less
invasive incision in the side of the body. The company's
visualization systems avoid nerve damage, reduce trauma and cut
operating times by half. In addition, patient recovery times are
faster, hospital stays are shorter and the body suffers less blood
loss and trauma.
As noted earlier, sales growth is starting to cool, but I still
expect NuVasive to grow at a +15% to +20% pace in the coming years,
thanks to a program that continually trains more doctors on the
company's platform. (Only 10% of all back surgeons have been
trained on the platform thus far).
NuVasive recently made a pair of acquisitions to bolster its
position in bone graft regeneration and in the field of cervical
disc replacement. The company is also rolling out new products
targeting specific back ailments like deformity and scoliosis.
Lastly, the company is just getting underway in the untapped
international market. International sales accounted for just 3% of
revenue in 2009, but with new offices opened across Europe, that
figure should rise to 10% to 15% within a few years.
Thanks to this summer's sell-off, shares now trade for less than 20
times next year's profits -- the lowest forward multiple in the
company's history. I think
earnings per share (
can reach $3 by 2013 thanks to steady sales growth and better
off of the company's fixed
. Shares trade for around 10 times that view. As investors come to
expect moderating growth that can be sustained in the long-term,
shares should re-visit the 52-week high of $46, which is roughly
+50% above current levels.
Luminex (Nasdaq: LMNX)
As is the case with NuVasive, this company has also adjusted to a
world of slower, albeit respectable, growth. Sales rose +40% in
2007 and 2008, and are now growing closer to +20%. That's fine with
me, especially since there is a clear case to be made that this
level of growth can be sustained for quite some time to come.
Luminex makes diagnostic tools for genetic analysis, drug
discovery, clinical diagnostics and biomedical research, and offers
exposure to a wide range of medical technology trends. The strength
of Luminex's technology lies in its ability to rapidly analyze
massive amounts of genomic and biologic data. Previous machines
were quite fast, but not fully accurate. Luminex's xMap system ends
that trade-off by offering highly-accurate and speedy results.
Luminex sells its gear to research labs, which also end up buying a
host of consumables used in the testing process. The company also
sells its software to other industry players, which incorporate the
xMap engine into their hardware. That technology is protected by
more than 50 patents, with an additional 100 patents pending.
Why do I think growth can be sustained? The company has more than
$100 million in cash, which has led to a strong jump in the
development of new products. For example, a 3-D mapping system has
been a recent hit with customers
This is not a cheap stock, trading at nearly 40 times projected
2011 profits. But as sales continue to grow at a steady pace,
profits should grow even faster in subsequent years. The company
has just emerged from a period of heavy investments that will
dampen 2010 profit growth, but set the stage for very robust profit
growth starting next year.
It's hard to place a target price on this kind of
, as the real value lies in the core technology and the ability to
, and not simply near-term profit trends. As Luminex continues to
grow at a solid pace in coming quarters, shares should break out of
their year-long mid-teens trading range and move up toward the $20
Action To Take -->
All three of these stocks make for good portfolio candidates. These
companies are building wide moats around their business by
investing heavily in R&D or growth-inducing acquisitions. They
may no longer be growing at extreme rates, but they appear to be
settling into solid long-term growth in the +15% to +20% range.
Shares may trade erratically, thanks to the occasional quarterly
miss, but should power higher into 2011 -- and beyond.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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