Cashing in on Edwards Lifesciences' Lower Forecast

By Palwasha Saaim - October 24, 2012 | Tickers: BSX, EW, ISRG, MDT | 0 Comments

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For companies, there's nothing good about missing analyst forecasts. Missing guidance often marks the beginning of troubles at the company, and of course the stock price slumps. But for investors, forecast misses are sometimes good news. When Mr. Market jumps to sell his shares on such misses (mostly irrationally) and builds a downward pressure on stock prices, he makes way for average investors like you and me to find reasonable entry points into companies we wish we could have bought at a bargain when we could. Only this week, we saw Google's stock plummet over 10%, only to regain 1.5% within a week--and the buying activity continues. Another company that missed forecasts this week is Edwards Lifesciences (NYSE: EW).

The biggest slump in its price in at least 10 years came earlier this month when the company warned ahead of its Q3 earnings announcement that its SAPIEN sales will be hit by troubles in Europe, Medicare issues in the US, and staff shortages during summers. This warning came before the FDA's approval of its TA procedure (I'll get to that in a bit). The approval came on Friday, the same day Edwards Lifesciences announced its Q3 earnings, missing sales forecasts but beating earnings.

EW's First Mover Advantage

So what is this TA procedure anyway? Transapical/Transfemoral Approach, short for Transcatheter Aortic Valves Implantation (TAVI), is a prodecure whereby an artificial heart valve is inserted into the patient's heart to replace his diseased aortic valve. The TAVI procedure is a breakthrough technology that is replacing open-heart surgery, the prior standard treatment for diseased aortic valves in which the patient's chest was cut open and his heart was temporarily stopped.

The TAVI procedure is performed in two ways--via Transapical Approach or Transfemoral Approach. The Transfemoral TAVI, which was approved by the FDA last year, is when the catheter is implanted into your femoral artery in your leg and is threaded to your aorta. The Transapical Approach (TA, as mentioned earlier) is the newly FDA-approved procedure in which the catheter directly reaches your aorta through an incision made in your chest. The procedure was earlier approved by the FDA, but could only be performed on patients on whom the transfemoral approach couldn't be performed. However, the new approval will allow the Transapical approach to be used on high risk patients, whether the patient can be treated with the transfemoral alternative or not. This will add a whole new population of patients to the TAVI procedure which, in the US, can only be performed using the Edwards Lifesciences' SAPIEN Transcatheter Heart Valve (THV), thus giving the company a monopoly over this procedure.

A quick look at Q3 and what lies ahead

Edwards Lifesciences generated a revenue of $448M, up 8.5% from prior year's Q3. EPS stood at $0.58, 35% higher than the same quarter last year. Operating margins came out at 21%, up 6.6% from the prior year. The company has pulled down its guidance of SAPIEN sales from $550M-$600M to $530M-$560M, and full-year EPS guidance went from $2.60−$2.68 to $2.54−$2.58. The company is expected to achieve a full year sales growth of 15% from last year. Edwards' CEO is optimistic that the FDA's approval of the TA procedure and the addition of the new 29 millimeter heart valve will help the company produce decent fourth quarter results.

Looming Competition

Edwards Lifesciences is, for now, the only manufacturer of its SAPIEN transcatheter valves in the US. However, fly to Europe and you'll find a competitor there, Medtronic (NYSE: MDT), with a similar product: the CoreValve. That's one reason why sales showed growth in all major regions, including the US, Japan, and the rest of the world except Europe. Sales in the US, Japan, and the rest of the world were up 28.5%, 6%, and 9.8%, respectively. However, European sales went south, down 17% from the same quarter last year.

Edwards' CEO Michael Mussallem doesn't see competition as a reason for sales decline in Europe. He cites the Eurozone's debt crisis and resulting austerity measures and hospital budget cuts as the reason behind the drop, though he continues to assure investors that Europe is going to be a lucrative market for its SAPIEN valves in the future and boasts Germany's 13% sales increase in the latest quarter as an indicator. The company generated about a third of its revenues from Europe this year, so troubles in the region might mean future forecast misses.

Nonetheless, I still believe that competition looms as a threat to Edwards, especially with two other companies coming into the picture--St. Jude Medical (NYSE: STJ) launching its TAVI heart valve and Boston Scientific (NYSE: BSX) launching a similar Lotus heart valve device. Conclusively, I believe that even if Mussallem is able to live up to his word in the next few quarters, greater competition in later years will bring down the company's market share, revenues, and margins in Europe. Additionally, its monopolistic hold in the US will also waver once Medtronic's CoreValve, which is already undergoing clinical trials in the US, gets approved by the FDA.

Fundamentals

A comparison of Edwards Lifesciences' fundamentals with some of its peers and industry players, including Intuitive Surgical (NASDAQ: ISRG), Medtronic, and Boston Scientific indicates that the company is healthy overall. Edwards has almost zero long term debt and has a debt to equity ratio of 0.13, better than both Medtronic's and Boston Scientific's 0.6. Free Cash Flows are appreciable at $125.6 million against revenues of $448 million, though not applaudable.

EW Free Cash Flow data by YCharts

Edwards Lifesciences doesn't pay dividends, but rewards shareholders through share buybacks. It repurchased 174,000 shares for $13.1 million during the latest quarter. Edwards' forward P/E is, on the other hand, high at 33.23, as opposed to Medtronic's very low 11.35 and Boston Scientific's 12.44; but it's better than Intuitive's P/E of 36.61.

So how's Wall Street rating the stock? RBC Capital maintains its 'outperform' rating and a $102 price target. Citigroup downgraded the stock post-earnings announcement from buy to 'neutral,' with a $95 price target. Credit Suisse has EW shares rated 'underperform'. On Motley Fool, Wall Street recommendations tracked by S&P Capital IQ have all analysts rating it as 'outperform,' with an average price target of $104. Wunderlich Securities rates EW as 'hold' setting a price target of $98 to $104.

Making the Call

With a forward P/E of 33.23, the company's average EPS guidance of $2.56 gives EW a fair value of $85.07. I call for a limit price between $84-$85 for a long position in the stock. But remember, future competition will change how the business looks today.

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