GROWING PAINS HIT THE HIGH FLYING MEDTECH STOCKS

March 2021 has been a particularly tough month for the SMID cap space in MedTech.  We composed a basket of SMID cap high-fliers – those companies whose stocks appreciated at least 30% in 2020 and in addition, reacted positively to their respective Q4:2020 results in 2021 - and compared their performance to a basket of stocks of more established but still 10%+ MedTech growth companies, like ISRG.  The aim of this exercise is to help determine if these negative re-ratings have bottomed out, and if a near-term rebound can be hoped for.

Our basket of SMID Cap MedTech high-fliers:

On average and as of 3/29/2021, the group corrected by 30.7% from each stock’s highest price reached during 2021. The average EV/ cons. 2022 REV multiple, at their highs, was 22.3x. Following the correction, it dropped to 14.9x. Overall, the Street estimates that the group will grow 2022 REV by 35.9%. Currently, one is paying 16.1x 2022 REV for an average growth of 35.9%, for a ratio of 0.46. Before the correction, the market cap/revenue multiple was 22.3, and a multiple/growth ratio of 0.67.

Our basket of 10%+ growth and more established MID-LARGE CAP MedTech stocks:

In the table above (on 3/29/2021), the basket of more established 10%+ growth stocks in the MedTech space has an average EV/ revenue multiple of 11.7x with an average estimated 2022 REV growth of 15.3%.  YTD, the stocks in the larger cap group is down from each of its highs by 13.8%. Similarly, the valuation multiples compressed by 13.8% (since consensus 2022 numbers didn’t change during the correction). The SMID-cap group’s valuation and valuation ratios dropped by 30.8%, or more than 2x that of the larger cap group. At a macro level in Q1 2021, it is well known that value outperformed growth. But in this example of medtech stocks, faster growth stocks markedly underperformed somewhat slower growth stocks. And none of the member stocks of either group can be thought of as a value name. Even when comparing medtech names with 30% growth vs those with 10%+ growth, growth became significantly cheaper.

In the two groups above, the ratio of the average EV/REV multiple for the MID-large cap group is 0.76 (last column, table 2), vs the current 0.46 for the high flier club,  for a difference of 39.5%.  In other words, for every % of revenue growth among the higher risk group, one is paying 39.5% less than in the case of the more established, slower growing 10+% growth group.    I should mention that the Street does not commonly use the ratio of the revenue multiple/revenue growth for valuation comparisons, as is the case with the earnings multiple/earnings growth (“PEG”).  Nevertheless, I find the revenue ratio – which normalizes for growth - directionally useful when evaluating the “cost of growth”. 

So, are we there yet?  Is the March correction of the 30%+REV growth group close to being over?  Certainly, this analysis adds to the argument that we’re closer.  The absolute multiple and ratio of the multiple/growth have compressed by 30.7%.  And the rate of compression for the SMID group was more than twice as high as that of the MID-LARGE cap group. That seems like an exaggerated divergence of valuation, since I don’t view one group as being more twice as risky than the other, and so I expect the good quality names in the first group, those with good quality Q1 results and guidance will outperform the members of the second group when the fundamentals on the Q1 call are similarly positive. Of course, market psychology based on appetite for growth, offset by relatively lower buy/sell discipline among retail investors will be highly influential, as will the yield on the 10-year Treasury note.  And on the face of it, a stock like INSP, still at consensus 2022 REV, looks quite expensive.  But if viewed on how much growth one is getting for 20.4x, it seems more reasonable. 

How does the riskier, faster growing group recover from the correction?  More than anything, in my opinion, it will depend on Q1:2021 quarterly results and to what extent the companies beat consensus estimates.    Which is why these stocks have been so vulnerable.  Absent any positive news in the form of quarterly results and pre-announcements, the group finds itself primarily judged by the 16.1x MC/revenue multiple.  Earnings season can’t come soon enough.