Medical device stocks have, in general, done a fair bit better since my last write-ups in the fall of 2023. As an above-average grower, that has largely been executing on its plan, it would seem reasonable to think that Coloplast (OTCPK:CLPBF) (OTCPK:CLPBY) (COLO-B.CO) might do even better, but I cited the stock’s “Fort Knox” price at the time of my last article and the shares have instead tracked the larger medical device space since then (up about 16%), outperforming rivals like ConvaTec (OTCPK:CNVVY) and Organogensis (ORGO), but lagging other highly-valued quality growth names like Boston Scientific (BSX), Edwards (EW), and Intuitive Surgical (ISRG).
Not much has changed regarding my fundamental view of the company or its shares – it’s a great growth story, protected in part by high barriers to entry, and a rare one-two offering of above-average growth and margins, but the valuation amply reflects this.
Harnessing Product Development To Drive Share Growth
Coloplast continues to execute well on its plan to leverage new product development and penetration into new and/or under-developed markets to drive above-average revenue growth. To that end, the 8% organic growth that Coloplast delivered in the last quarter (the company’s fiscal second quarter) likely exceeded underlying weighted average market growth by at least 300bp.
Sales in the Ostomy business continue to outperform the market, growing about 7% in the last quarter on the back of healthy demand in emerging markets like China (up high single-digits) and new products like SenSura Mio Convex, even with a weaker result in the U.S. due to order phasing. Continence, too, was a strong performer last quarter, growing about 8%, as did Wound/Skin Care. The smaller Voice & Respiratory business grew 13%, while Urology grew 5% (versus almost 10% growth at Boston Scientific).
While the company has seen some currency and cost headwinds, adjusted operating income only lagged revenue growth moderately, with margin down 40bp to 27.2% – a fine result compared to companies like BSX (at 26.2% in the last quarter).
Innovation Can Continue To Support Growth
Coloplast management has not been afraid to take significant swings at growth through M&A, including the $1.3B acquisition of Kerecis in 2023 and the $2.5B acquisition of Atos (now the Voice and Respiratory Care business) in 2021. Importantly, though, the company has continued to devote resources to internal product R&D and innovation.
Building on the success of SenSura Mio, management is looking to launch follow-on support offerings including black bags and the Convex Soft w/ Flex product. In Continence, the company has seen good uptake of the Luja intermittent catheter (which offers advantages like free flow without repositioning through its Micro-Hole Zone technology and a corresponding lower risk of infection), and the company is now preparing to launch a version for women.
In wound care, the company has continued to see strong growth from products like Bitain Silicone, as well as Kerecis, with the latter delivering 35% revenue growth and 10% adjusted margin in the last quarter as the company continues to invest in scaling up the business (largely by expanding the sales force). Kerecis now has around 5% share in its addressable markets, making it the #5 player, and I see ongoing issues at Integra LifeSciences (IART) as an opportunity to gain share across its portfolio.
I also believe there is relatively little long-term risk on the reimbursement side. Coloplast shares sold off on the news that that Kerecis would be excluded from CMS reimbursement due to a lack of clinical qualification, but management is submitting data during the consultation period that demonstrates strong clinical benefits like higher rates of wound closure (57% versus 31% for the standard of care) and higher wound area reduction (86% versus 64%). Losing outpatient Medicare reimbursement would impact about 20% of the sales, but again I believe Kerecis will ultimately be included when the final decision is announced in 2H’24.
Looking at the other businesses, Coloplast management is targeting share growth in chronic tracheotomy through product and market development. Given similarities to the ostomy and continence businesses (highly chronic conditions, low tolerance for failure, and relatively little interest or innovation from major med-techs or VC-funded start-ups), I believe this can mature into appealing business for Coloplast, and the business is still significantly under-penetrated in the U.S.
I’m less bullish on the Urology business. While thulium fiber laser treatment of benign prostate hyperplasia has its place – the approach is generally much more reliable in terms of tissue volume removal – the higher incidence of side-effects (including incontinence and retrograde ejaculation) is likely to support ongoing growth for water vapor-based therapies like Boston Scientific’s Rezum.
The Outlook
Management reiterated robust targets at its June 2024 Capital Markets Day, including revenue growth of 8% to 10% in organic terms and adjusted EBIT margins over 30%.
Although I don’t think the company is going to hit 10%, I am looking for 9% revenue growth over the next three years and growth of between 7% and 8% over the next decade. In markets like ostomy I still see meaningful opportunities for the company to build share in markets like the U.S. (where its share lags its EU share by at least 15%) through product innovation and sales force execution. Likewise in continence care, wound care, and respiratory care.
On margins, I expect EBITDA margin to improve a little over 32% last year to over 34% over the next five years, pulling free cash flow margins up into the 20%’s and driving mid-teens long-term FCF growth.
None of that really helps the valuation argument, though. The shares are pricey on discounted cash flow (not unusual for a growth med-tech company), but likewise on my growth/margin EV/revenue approach. There have long been pretty reliable correlations between a med-tech’s revenue growth and margins and what the Street is willing to pay, and Coloplast trades above that range. I concede that large-cap medical technology stocks with high single-digit revenue growth, 30%-plus EBITDA margins, strong free cash flow, and strong market share are not common and deserve a premium, but it takes a 7.5x revenue multiple just to get to today’s valuation.
The Bottom Line
High valuation isn’t an impediment to further gains for growth stocks and if you’re a growth-oriented investor, you’re likely not that concerned about Coloplast’s valuation. That’s fair enough and it could still work out; I certainly don’t expect any meaningful shortfalls in growth. For me, though, I still believe in the concept of growth at a reasonable price, and I don’t find Coloplast’s price to be reasonable enough to coax me to buy today.
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