We are lowering our 12-month rating on Integer Holdings Corp. (NGS: ITGR), a medical device outsource manufacturer, to HOLD from BUY, but are reiterating our five-year BUY rating. ITGR has been impacted by the spread of COVID-19, with the shares down 28% year-to-date, as sales of the company’s products have fallen amid delays in elective surgical procedures. We expect this weakness to continue into the first quarter of 2021, with sales returning to prepandemic levels in 2Q21 at the earliest. We also note that Energy sector demand in Integer’s Electrochem segment has faltered, minimizing the benefits of the company’s diversification strategy. That said, we expect the company to perform well over the long term and look for a return to growth as the pandemic recedes and patients become more comfortable scheduling elective procedures.
Integer has relied in part on its R&D capabilities to drive growth. On June 25, the company opened The Galway Research and Development Innovation Center in Ireland, enhancing its ability to develop high-quality medical devices and technologies. The Innovation Center will enable Integer and its customers’ teams to work together to develop new devices.
The company has also relied on partnerships to spur growth.
Integer reported second-quarter results that missed consensus revenue and earnings estimates. On July 30, Integer reported 2Q20 adjusted income from continuing operations of $0.32 per share, below the consensus of $0.36. Adjusted earnings fell 74% from the prior year, reflecting both a sharp decline in volume and the maintenance of infrastructure to support the return of sales post-COVID. Organically, adjusted EPS fell 76%. Revenue fell 24% on both a reported and an organic basis, to $240 million, missing the consensus estimate by $4 million. Adjusted EBITDA from continuing operations fell 56% to $33 million. The average diluted share count increased 36 basis points to 33.1 million.
While the company typically provides guidance, management suspended its previously announced 2020 guidance along with its first-quarter results, citing uncertainties related to the pandemic. It did not reinstate guidance with its 2Q20 results, but expects 3Q to be similar to, or slightly weaker than, the second quarter. It also expects cash flow to remain positive in the second half of the year, but to decline from the first half due to reduced cash collections. In the fourth quarter, management looks for sequential improvement, with results coming in between third-quarter and pre-COVID levels. It expects market conditions to return to pre-COVID levels sometime in 1Q21 assuming no further resurgence in coronavirus cases.
EARNINGS & GROWTH ANALYSIS
Integer is working to optimize its portfolio, product line, and operations. The company has invested in its cardio & vascular, neuromodulation, electrochem, and portable medical businesses, and intends to make additional investments going forward.
Cardio & Vascular sales fell 14% in 2Q20, to $129 million, driven by weak sales resulting from the pandemic in all markets except for structural heart. The company’s nonmedical segment, Electrochem, saw sales fall 48% to $9 million, driven by a significant downturn in the Energy sector related to the pandemic.
FINANCIAL STRENGTH & DIVIDEND
Moody’s has not rated the company’s debt, although it has set a Corporate Family Rating (CFR) for Greatbatch Ltd., a subsidiary of Integer, of B1/positive.
MANAGEMENT & RISKS
The company faces significant competition from other outsourced providers in its key cardiac, neuromodulation, and vascular markets. It also faces regulatory and trade risks as a manufacturer of medical devices. In addition, the company faces the risk that patients will delay non-COVID-19 medical visits and postpone elective surgeries due to the pandemic. Nevertheless, while demand for certain products will likely fall as a result of the virus, healthcare providers are relying heavily on the medical technology industry for certain key items, as evidenced by the increased sales of Integer’s ventilator and patient-monitoring components.
The Medical unit includes portable medical, cardio & vascular, and cardiac and neuromodulation products.
ITGR shares have been volatile over the past two years, but have advanced 29% from their pandemic low of $46.01 in March. However, at one point, they traded nearly 90% above their March low before pulling back to current levels. Furthermore, the stock’s 50-day moving average is below the upper band of the channel, potentially creating additional levels of resistance at an even lower value.
As such, we are lowering our 12-month rating to HOLD. We would consider returning Integer to our BUY list on signs of sales and margin improvement or a sustained reduction in COVID-19 cases.