INVESTMENT THESIS
We believe that the divestiture of the capital-intensive orthopedics business will lead to stronger organic revenue growth and margin expansion. We also believe that Integra is well positioned for stronger growth post-pandemic with help from increased regenerative tissue production capacity, recently acquired products, and continued expansion in overseas markets.
RECENT DEVELOPMENTS
We see Integra’s pending sale of its Extremity Orthopedics business to Smith & Nephew for $240 million as an addition by subtraction. By offloading the capital-intensive orthopedics business, which makes replacement joints for wrists, shoulders, ankles and feet, the company should be able to generate stronger revenue growth and increase profitability. Based on the company’s results over the past two years, the exclusion of orthopedics would have added approximately 50 basis points to organic growth, reduced operating expenses as a percentage of sales by 170 basis points, and increased the EBITDA margin by more than 140 basis points.
The orthopedics business simply did not have the size and scale to compete effectively in an industry that is consolidating around larger players.
Integra posted strong 3Q20 results on October 28 despite the impact of COVID-19. Adjusted EPS rose 17.6% to $0.80 and topped the consensus estimate by $0.26. GAAP net income was $32.3 million per share a year earlier. Revenue totaled $370.2 million, down 2.3% from the prior year as reported and 1.5% on an organic basis. At the same time, we note that revenue grew 43.1% sequentially.
While procedural volumes improved sequentially from 2Q20, the pace of improvement remains uncertain as hospital capacity is being increasingly strained by the surge in new coronavirus cases.
By business segment, CSS revenue fell 5.4% to $239.3 million. CSS includes neurosurgery products and instruments. Revenue from the Orthopedics and Tissue Technologies segment rose to $130.9 million, up 3.8%. OTT includes the wound reconstruction and care business, private-label products, and the soon-to-be-divested extremity orthopedics.
Helped by a favorable geographic and product mix, careful expense management, and greater-than-expected revenue growth, the company achieved leverage in the income statement, boosting the 3Q adjusted gross margin by 160 basis points to 68.6%. The adjusted EBITDA margin was 27.9%, up 370 basis points.
EARNINGS & GROWTH ANALYSIS
It expects the OTT segment to continue to post year-over-year revenue growth in the U.S. The combination of growth in U.S. OTT and steady recovery in neurosurgery would enable Integra to post flat overall revenue in 4Q. Still, management remains cautious amid the current spike in COVID-19 cases in Europe, notably in France, Italy and Spain. If hospital capacity continues to be strained, Integra could see a mid-single-digit revenue decline.
Management expects the EBITDA margin to be sequentially lower in 4Q20, though still higher than in 4Q19. It plans to ease cost controls, likely resulting in slightly higher manufacturing expenses.
FINANCIAL STRENGTH
The stock does not pay a dividend.
MANAGEMENT & RISKS
Integra faces risks from the integration of acquired businesses and from disruptions to its manufacturing processes as it upgrades functionality and expands capacity. Given the impact of the pandemic on hospital procedures, Integra faces the risks of adjusting costs to reduced sales volume. At the same time, it must minimize disruptions to its manufacturing facilities and supply chain. The company also faces pricing pressure as hospitals seek to lower the cost of supplies, equipment and implants. Insurers may also seek to reduce reimbursement for certain surgical procedures.
COMPANY DESCRIPTION
Based in Plainsboro, New Jersey, Integra is an integrated medical device company that develops and markets devices for use in neurosurgery, wound repair, and the orthopedic reconstruction of joints in extremities such as shoulders, wrists, ankles and feet. The company’s products are used in cranial and spinal procedures, peripheral nerve repair, repair of skin and deeper tissue from burns and vehicular accidents, and the repair and reconstruction of soft tissue. The company also markets products through private-label relationships with larger medical device companies.
VALUATION
IART trades at 18.9-times our 2021 EPS estimate, near the average of 19.0 for peers in our med-tech coverage universe. We believe this is an attractive valuation. As one of the smaller med-tech companies by market cap in our coverage universe, Integra is able to ‘move the needle’ on revenue and EPS growth through tuck-in M&A deals.
On December 10, BUY-rated IART closed at $58.96, up $2.54.
Source: Argus
