Medical Device Stocks: Potential Gold Mines or Land Mines?

December 8, 2022
Medical device stock sector expert Mike Polark, CFA, is a Director and Senior Analyst at Wolfe Research.

Mike Polark, CFA, is a Director and Senior Analyst at Wolfe Research

Medical device stocks are a very heterogeneous sector.

Mike Polark, CFA, is a Director and Senior Analyst at Wolfe Research, LLC covering the medical device industry. Mr. Polark joined Wolfe Research after nearly 10 years with Baird.

In this 2,870 word interview, exclusively in the Wall Street Transcript this month. Mr. Polark details his top picks and reasoning behind them.

“In the worst of the pandemic, surgical procedure volumes were net negatively impacted. There were fewer surgeries done.

There were fewer physician office visits done. So let me put it this way, this group was not a COVID beneficiary defined at the highest level — COVID created a headwind.

And so that was very much the story of 2020 and even some of 2021.

I think we’re obviously beyond the acute phase of COVID and now we’re kind of in a COVID endemic world and COVID is still creating some challenges.

They’re less severe than they were.

But it’s still a struggle for hospitals and health care providers.

And so, yes, I think the other way to frame it is — if you were in 2019 and we’re pre COVID, and you were projecting surgical procedure volumes in 2022 or 2023 and then you go to look where we are now with COVID, we’re below where you would have thought we’d be, where you would have thought we’d been in 2019.

So we’re still underperforming as a consequence of the pandemic. And I don’t think there’s an overnight fix; it’s not going to catch up all of a sudden even if the patient demand is there.

And I think the reason it might struggle to catch up is because of the supply side — the providers that help the hospitals, the physician offices, they just don’t have enough bandwidth to allow all this potential pent-up demand to come back all of a sudden. And so it can be smoother sailing from here for sure, versus what we’ve had the last couple years, but a lot of folks like to talk about the backlog or the pent-up demand for health care services of all types because of COVID.

And I conceptually believe that it’s there, but I also don’t believe it can all of a sudden come back because of these supply constraints.”

Inflation is also a concern for medical device stocks as well as COVID-19.

“…Inflation, certainly it’s a consideration, a headwind, that companies are working through at the highest level.

It seems to be more acute in companies that make equipment versus interventional products. But I think the impacts are broad, and I think what these companies are attempting to do, and this includes the biggest of the med device companies, like Medtronic (NYSE:MDT) and Boston Scientific (NYSE:BSX) and Abbott (NYSE:ABT) that I follow, historically they have not captured price increases.

Historically their model was pricing each year flat to down a little bit. And that seemed to work for their business when the CPI was +2 or +3. CPI is now +5, 6, 7,  8.

And pricing flat to down is no longer supportive of their overall business goals. And so they are attempting to, again, at the highest level, at the portfolio level, to reorient and start to advocate for some modest price increases where appropriate.

And so I think, you can only turn the aircraft carrier so fast; it’s slow to develop. But the goal is that if historically, pre COVID, your pricing was -1 or -2 at the enterprise level, today, I’m sensing they kind of want it to be +1 or +2, given where CPI is to cover their costs. And so that’s how the industry is responding to clearly increased costs that they’re facing.”

Innovation in automation is essential to the medical device stock sector.

“Robot-assisted surgery is a major development — all sorts of ways to advance minimally invasive surgical procedures continue to get adopted.

So robots are a piece of that.

But there are other tools and techniques in cardiovascular medicine that can further minimize the exposure for patients, the amount of time they stay in the hospital.

You think about a procedure like TAVR — transcatheter aortic valve replacement — a huge home run for the industry broadly.

The standard of care 10 years ago was surgical aortic valve replacement, which is an open-chest procedure. And if you can avoid stopping a heart and opening the chest you would, and TAVR came along and allowed all sorts of aortic valves to get replaced without that intense intervention.

Same for coronary angioplasty.

So this is a catheter-based technique to clear out blocked coronary arteries.

The alternative is coronary artery bypass grafting, which is an open-chest procedure.

So, open-chest procedures still have their role in the field, they’re still used, but you’re seeing interventional cardiology, these catheter-based techniques where you access the heart from a blood vessel in the leg, are continuing to ramp in popularity and adoption.”

Further medical device innovation is in the close tracking of bodily functions.

“A different trend is smart sensors. Think about wearables defined broadly — certainly you’re seeing wearables play a bigger and bigger role in health care, both in the hospital setting and outside the hospital setting.

Certainly the consumer wearables ecosystem is massive, but when I talk about wearables, I’m focused on companies with FDA clearances, medical-grade wearables, and you’re seeing these devices really increase in popularity and use.

And I think the long-term vision is more of this, and more ways to watch patients, monitor patients outside the hospital, especially patients with chronic conditions.

And then you see wearables really change the paradigm in diseases like diabetes management — the continuous glucose monitor, patch-based insulin pumps — with huge benefits to patients and their daily living. And you’re really seeing companies that sell those devices have huge surges in their revenue performance.”

One medical device stock that fits this thesis is Masimo.

“I like Masimo (NASDAQ:MASI). It’s a mid-cap stock — $7 billion, 8 billion in market cap.

It’s a smart sensor company.

They have leading market share in the hospital for certain vital signs monitoring of respiratory vital signs.

So they’re the global leader in hospital-based pulse oximetry.

And they have some interesting opportunities outside the hospital in the home, to help hospitals and health care systems watch patients more closely.

The stock has come down a lot this year.

They’ve done an acquisition, that’s a little confusing, but that’s created an opportunity in valuation, and I’ve advocated for a sum of the parts approach to this stock.

And I don’t think you’re paying up too much for a really high-quality core business at this point. So you’re getting it, relative to this company’s 10-year history, you’re getting the opportunity to invest in the core business at a below-average multiple.”

One recognizable medical device sector stock that is not high on Mr. Polark’s list is Abbott.

“I have an “underperform” rating on Abbott Laboratories.

Abbott is a very large company, they do a lot of stuff, they have some great brands — Abbott a good company.

I just think right now it feels like a potentially bad stock.

And the primary issue for me, or the primary concern for me, is that the last two years, they have had a surge in profit from COVID testing. They sell rapid tests like BinaxNOW here in the U.S. and obviously that’s taken off.

So when you look at the last two years of financial performance, it looks really good and differentiated versus other med techs through the pandemic, but it seemingly was driven predominantly by the COVID testing, and we’re coming down from the COVID testing mountain top.

And I think we’ve seen the peak there.

And I just worry, as the next year or two unfolds, as we enter a new normal or a new era of COVID with maybe less testing generally — obviously, we’re seeing the molecular testing go way down and I worry that the rapid testing might see a similar decline.

It creates a tough dynamic for their income statement to manage through that huge pop which is then kind of deflating.

I do a lot of work around, what is the business earning otherwise.

And I just think that number is maybe not as high as some folks think, and using an average valuation has gotten me a stock price that’s been consistently a bit below where it’s traded.

So it’s not a table pounder, but I do think as 2023 unfolds, this whole COVID testing tide going out will be more visible in the numbers, and I just worry that it’ll result in a little bit of a further reset of the stock price.

So that’s one that I’m kind of differentially cautious on.”

Medical device stock expert Vijay Kumar is a Senior Managing Director on Evercore ISI’s Healthcare Services & Technology Research Team

Vijay Kumar, Senior Managing Director on Evercore ISI’s Healthcare Services & Technology Research Team

Vijay Kumar is a Senior Managing Director on Evercore ISI’s Healthcare Services & Technology Research Team, primarily focusing on the medical supplies and devices and life science tools subsector.

Dr. Kumar’s research expertise spans the diagnostic, medical equipment, medical supplies and life science tools subgroups. In this  June 10, 2022 2,430 word interview, Dr. Kumar reveals some mid year medical device stock recommendations that have come to fruition.

Medtronic has had some recent setbacks on the new product pipeline side. And most of it is either about unfortunate timing, or a communication sort of issue.

Yet the underlying fundamentals remain very strong.

We see three key products for Medtronic, positioned to help the stock.

They recently launched their surgical robot, a soft tissue surgical robot, in Europe. It’s doing extremely well.

And they will start their U.S. IDE trial — clinical trials shortly. We do expect an approval in calendar 2023, and we think the prospects for surgical robotics for Medtronic are very bright.

However, they did get a recent warning letter issued within diabetes.

So they were expecting a new product approval called the 780G, which is now under a question mark, given the warning letter. We think the issues that the FDA has raised, they were all legacy issues — it has nothing to do with the new product.

Within the clinical superiority of the new product, 780G makes a case for approval.

So if 780G were to be approved, that’s a positive.

And there is a pivotal trial readout coming out in the back half of this year, which is a renal denervation trial for resistant hypertension.

So if we do get a positive readout in the trial, that opens up a new multibillion dollar opportunity.

If you have these clinical pipelines, it’s a very healthy balance sheet. We think management has done a good job, and a changing culture within all these elements make for Medtronic to outperform.”

Innovation in medical device sector stocks always provides upside.

Medtronic would be the one with renal denervation.

This resistant hypertension is a massive opportunity globally.

And these are patients with systolic blood pressure of above 165 millimeters of mercury, and not responding to three or four medications.

So there’s no option for them.

So these patients are on three or four different pills and those regimen cocktails need to be changed regularly to see what sticks. And there’s nothing else that could be done.

And multiple trials have shown lowering blood pressure is correlated with the huge clinical and economic value to the system over time.

And that’s where renal denervation comes in.

How the therapy works is, you first ablate the sympathetic nerves around the renal artery. And those sympathetic nerves have a feedback loop when they’re activated, and they can cause constriction of blood vessels.

When blood vessels constrict, that raises the blood pressure.

So in this therapy when you ablate the nerves, that feedback loop is cut.

So you may not have the increase in blood pressure because blood vessels now relax, and you get an immediate drop off in blood pressure.

So what makes this therapy really cool is, one, its novel; it’s completely greenfield.

No one has looked at this kind of therapy.

And two, once you get this procedure, it’s seen as a permanent therapy.

You could perhaps even reduce the number of drugs that people take over time. So it makes it quite exciting.

And we’re expecting the pivotal trials readout later this year, perhaps in Q4.”

Get more insight into these and many other medical device sector stocks, only in the Wall Street Transcript.