NuVasive’s Valuation Prices In An Excessively Bearish Outlook (NASDAQ:NUVA)

When a med-tech stock, particularly an established one, seems to be undervalued on the basis of both its cash flow and growth, it’s wise to reconsider your assumptions. While NuVasive (NUVA) enjoyed a honeymoon period after Chris Barry was brought on as CEO, the company has been smacked by COVID-19, and delays with the Pulse platform and better relative performance at rivals like Globus (GMED) have led to questions about whether the company can still drive meaningful share growth and margin leverage.

NuVasive has been a tough stock to recommend in the past, as it seems to always find a way to snatch defeat from the jaws of victory, and the shares have been a long-term laggard in the med-tech space. While I’m worried about blundering into a value trap, I believe there are still real opportunities in product platforms like X360, Cohere, Coalesce, and Modulus, and I believe that Pulse, whenever it finally reaches the market can drive some incremental growth. With the shares looking undervalued below the low-to-mid $60’s, I think this is a risk worth taking for investors who don’t want to chase pricier names that have already run.

Familiar Drivers For A Better Quarter

NuVasive posted a better than expected quarter, and like so many in the med-tech space (ortho/spine in particular), better-than-expected patient counts were the main driver. While non-trauma spinal procedures are technically “elective”, the underlying conditions tend to be quite painful, and the younger average age of spine patients argues for a somewhat faster re-normalization of procedures.

Revenue fell 30% in the second quarter, beating expectations by 16%. NuVasive’s growth lagged Globus (which reported 24% organic revenue contraction) and Medtronic (MDT) (down mid-teens, but on a different calendar cycle), but largely kept pace with Zimmer Biomet’s (ZBH) SET segment and managed to beat Stryker’s (SYK) 40% decline.

U.S. Hardware sales declined 29%, though demand for X360 remains healthy, and U.S. Surgical Support revenue declined 36%. OUS sales declined 26%.

Margins were mixed. While reported gross margin was quite weak, declining almost 13 points and missing by more than six points, there was a significant charge for excess/obsolete inventory driven by COVID-19. Exclude the charge and the gross margin decline was 260bp and the company beat by about four points. Likewise, while the company reported a slightly smaller operating loss on an as-is basis, adding back the charge would have brought operating income almost flat, and a meaningful beat versus sell-side expectations ($25M on $204M in revenue).

Mixed Near-Term Trends

While NuVasive saw a significant improvement in procedure counts during the quarter, from a 70% decline early in the quarter to a low double-digit decline in June, the commentary wasn’t as bullish as from Globus. Management indicated that July patient trends were “in line” with June, while Globus has seen double-digit growth in both June and July.

I touched on this some in my recent articles on Globus and Zimmer, but there are some idiosyncratic factors that could be driving the difference. Looking at the relative performances, though, I do think NuVasive is suffering from a lack of a robotics system (and the resulting volume pull-through), as well as weaker “through the cycle” investments in reps relative to Globus. Globus may also be getting an edge from a more dynamic portfolio of recent product introductions, as aggressive new product development remains a hallmark of Globus’s strategy.

Management was somewhat cautious on guidance, but I believe that may be prudent given NuVasive’s corporate history of over-promising and under-delivering. While I believe the procedure recovery trend is firmly in place, I can’t rule out risks from localized recurrences of COVID-19 over the next few quarters.

A Frustratingly Slow Pulse

Pulse was supposed to be a major driver for NuVasive, combining a robust set of tools including monitoring, planning software, imaging, rod-bending, and a navigation system custom-designed for spinal procedures (most nav systems are repurposed from other uses). While the company’s decision to listen to surgeon feedback and make modifications to the platform is the right call for the long-term, it has led to launch delays. Now it looks as though the commercialization of Pulse will be a 2H’21 event. With the delays in the Pulse platform, including both refinements to the system and challenges created by COVID-19, the development timeline for the new robotics platform has also suffered. First-in-man testing has been pushed into 2022, making it highly unlikely that it will be launched commercially before 2023. Medtronic and Globus already had big leads on NuVasive in robotics (for years NuVasive’s former CEO talked down the utility and importance of robotics), but that lead is only going to get longer and it gives other rivals like Stryker and Zimmer more time to get into the game as well, with both companies having existing ortho systems that can serve as foundational tech for a spinal procedure robot.

The Outlook

There are legitimate reasons to be nervous about NuVasive’s prospects, particularly with Medtronic and Globus executing well in the market. I do think new management has made more progress than the share price reflects, though, and as procedure volumes recover I think we’ll see more strength from offerings like X360, Coalesce, and Modulus – Modulus is a family of 3D-printed implants, and Globus has been aggressively expanding 3D-printing capacity.

I’m not expecting NuVasive to outperform Globus; while I expect high single-digit long-term revenue growth from Globus, I’m looking for mid-single-digit growth from NuVasive. I also do expect improving margin and FCF margin leverage, but this has long been the carrot at the end of the stick for NuVasive investors and I can fully understand disappointed investors taking a “I’ll believe it if I see it” stance. If management can execute, though, I believe high-teen FCF margins are attainable, driving low double-digit long-term annualized FCF growth.

The Bottom Line

NuVasive’s valuation says that’s not likely to happen, and the shares trade as though the company were going to be stuck with sub-20% EBITDA margins for a while and/or three-to-five year revenue growth in the low single-digits. While I do acknowledge the many and varied risks here, I think the market is pricing in an overly bearish scenario and I think these shares hold some relative value appeal here as the company fights to restore its growth credentials.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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