The next big ‘Peter Lynch-style 10-bagger’ from Roadrunner Stocks

Which stock are they calling the heir to Intuitive Surgical?

Roadrunner Stocks is a newsletter run by Jim Fink at Investing Daily, and I think I’ve only covered his teaser pitches once before — that was back in October, and the four stocks he touted at the time are more or less a wash over that time period, half better performers than the market and half worse.  This latest pitch from him is a bit more interesting, though, because it’s a fairly well-reasoned argument for a single stock … and it’s in a sector that I agree is worth checking out.

Whether or not that means his idea works out is an open question, of course, but the great Gumshoe faithful want answers … so let’s go get ’em.

The idea he’s touting he calls “Operation 10X” — an opportunity to make ten times your money, the fabled Peter Lynch “10-bagger” that every investor lusts after. And it’s an orthopedics company.

And, of course, as with all good medical device stocks it gets held up to the mirror to see if it might bear a passing resemblance to Intuitive Surgical, the skyrocketing maker of the minimally invasive da Vinci surgical system (and yes, every time I see this I get a little grumpy — I sold my ISRG shares back in 2008, after a nice run but still more than $200 ago… I guess it’s some consolation that I haven’t had to sit through their rollercoaster run of $500-300-$500-$300 over the last year). Here’s what Fink says:

“Individual investors who recognized Intuitive Surgical and rode the powerful mega-trend for a few years got rich. And I mean really, really rich!

“Am I suggesting you buy Intuitive Surgical stock now? No. Absolutely not. That opportunity is over. It’s done.

“You may have missed Intuitive Surgical rocketing 2,624% higher. (Don’t feel bad, so did I!)

“But you are NOT going to miss this next one!

“And how do I know this?

“Because I’m going to make darn sure you recognize the next mega-trend on Wall Street that’s happening right now!”

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I’m not so sure ISRG is “done”, though as a $14 billion company it’s already grown into its business quite a bit — it is, at least, more reasonably valued now than it has been in a long time, and I think many investors probably understate the value of having a ten-year head start on other robotic surgery systems and a large base of trained doctors who use your tools… but we’re not talking about ISRG today. What is the company they’re teasing for Roadrunner Stocks? Here are some more clues:

“My next 10-bagger was born when an orthopedic surgeon at the Mayo Clinic had a vision. The doctor had worked with several orthopedic companies and thought he saw some things the industry could do differently, and better.

“This surgeon believed in the Mayo Clinic mission that the needs of the patient come first. He wanted to make a difference in the quality of care provided to his patients suffering pain and loss of mobility from joint diseases.

“After leaving the Mayo Clinic, the surgeon started his own orthopedic company and then took it public. He is determined to provide innovative joint-replacement products designed by surgeons for their patients.

“The firm is now one of the world’s fastest-growing orthopedic companies. Sales exploded and they carved out a significant share of the $40 billion orthopedic implant market….

“My top-secret recommendation develops, manufactures and sells orthopedic implant devices, related surgical instrumentation and biologic services to hospitals around the world.”

The orthopedic market is pretty concentrated at the top, at least in the big areas like hip and knee replacements, with Johnson and Johnson (JNJ), Stryker (SYK) and Zimmer Holdings (ZMH) sharing dominance in most areas, but there are a surprisingly large number of smaller players who bring innovation and niche expertise… I guess there will always be entrepreneurial surgeons who think they can make a better shoulder socket, and many of the startup companies end up being bought out by the large firms or merging with each other, just like in pharmaceutical development.

So this isn’t a tease for one of those biggies — they are all pretty solid companies, and Zimmer is actually looking pretty interesting again (I suggested that one back in 2009 as the cheapest of the knee-and-hip crowd, but dropped it when it narrowed the valuation gap — it has since done very well, and I really like their deal to buy Biomet and almost double their size), but Fink is suggesting a far smaller company… you can’t make a “10 bagger” claim with a straight face when your stock starts at a $15-20 billion market capitalization.

His pitch relies on the increasingly demand for joint replacement, with arthritis hitting the baby boomers hard and with the market only improving as Medicaid covers more and more patients (people who previously would never have been able to afford a new hip).

Here are some more clues:

“… they have cutting-edge, industry-leading orthopedic products protected by over 100 crucial patents….

“… inked a long-term deal with Premier Healthcare Alliance. The contracts are for bone cement and total joint replacements including hip, knee and shoulder implants. Premier is one of the largest healthcare specific purchasing alliances in the United States….

“… quietly acquired two key competitors. These targeted acquisitions allowed the company to expand vertically into the rapidly growing spinal surgery area….

“… strong top-line and bottom-line growth, free cash flow and a pristine, debt-free balance sheet….

“The CEO and Prominent Wall Street Fund Managers Effectively Control the Public Float of Stock.

“The company only has 13 million shares outstanding. But the former Mayo Clinic surgeon who founded the company and is now the Chairman and CEO owns over three million of those shares, so the actual public float is about 9 million shares….

“… other major holders are BlackRock, Gabelli Funds, Vanguard, Wells Fargo Private Wealth Management, Goldman Sachs and Kennedy Capital Management.”

Ring a bell for anyone? No? OK, we’ll feed the clues into the gaping maw of the Mighty, Mighty Thinkolator — which boasts a nice new undercoating after our harsh New England winter. We get our answer pretty quickly for a Monday morning, this is: Exactech (EXAC)

Which is indeed a small orthopedic implant company, with a market cap around $300 million. And it’s been public for almost 20 years, so it’s actually a little bit surprising that it’s still independent — though the large insider ownership may have something to do with that (the founder and his family are still running the show, and along with other insiders they control about 40% of the stock). They primarily sell systems for hip, knee and shoulder partial and complete replacement, but also offer a variety of implant and cement products for orthopedists and do have a growing spinal business that they built through acquisition.

Doctors love investing, so hopefully we’ve got a few orthopedists out there who can opine as to where Exactech’s products fall in the spectrum — I don’t know what their competitive position is, just that they are dramatically smaller than Stryker and Zimmer and they are presumably at a sales disadvantage when going up against the massive sales forces at those larger firms. Orthopedic devices typically have high gross margins (meaning, the cost to build a knee implant is far less than they can charge for it), so when you’re small a new product or a little bit of growth can have a bigger impact, but it also means you’re less efficient (profit margins are considerably smaller than the big guys) — which is why big companies can show a nice return by swallowing up small ones and getting rid of extra overhead.

The lead products for EXAC are really knee replacement, including a medical device they’re selling called the GPS system for placing and aligning knees, and extremities, including their fastest-growing product, the Equinoxe shoulder system. They are growing their spine business, too, though it’s still quite a bit smaller than knee, hip and extremities — and they’re seeing some slack in their biologics business (bone implant material, particularly). If you think the analysts are on target and the company is going to grow earnings at an average of 10-15%, then it’s certainly a reasonable buy here — but for this year the company is guiding to only about 8% earnings growth, so that makes it a little bit tighter (analysts see them popping up to better than 10% growth in 2015).

They have beaten earnings estimates for several quarters in a row, but they haven’t been “blowout” beats — just a few percent each time. And they do, as teased, have some excellent small cap fund managers from Royce and Gabelli holding shares, large insider ownership, a fairly quiet (maybe not intentionally) push into growing their spine business and improving their salesforce — including a push into selling their GPS knee system, which they hope will spur more knee implant sales. They’re also continuing a transition of leadership, though that’s clearly been in the works for a long time (David Petty is taking over as CEO from his father, founder William Petty). Looks like an interesting stock, but that’s all I know about ’em so far — if you have an opinion on EXAC or other orthopedic implant companies, feel free to let it out to breathe… just use the friendly little comment box below.

And, of course, if you’ve tried Roadrunner Stocks we want to know what you think of ’em, just click here and you can review that letter for your fellow investors (we sometimes forget to ask, but we’re always happy to hear about letters our readers have subscribed to — you can click here to see the alphabetical list of all the letters our readers have reviewed, or to add your own thoughts).


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sgf
sgf
6 years ago

I am a “very” active 50 year old slender female who found herself needing a total hip replacement at a very early age. I have since been researching this area. I have had my very successful (anterior approach) replacement with a Smith and Nephew device. As Dr Bonz mentioned, I chose my surgeon,(sports medicine group) and due to his expertise with the Smith and Nephew product, he chose the prosthesis he preferred for my situation. All of the printed material the hospital and the group gave me, was printed by Smith and Nephew, I do not know if this is the only company the “hospital” uses.

Since researching this area I have been acquainted with more and more people that are needing this treatment at an earlier age. I think the thesis for investing in a joint prosthesis manufacturer is a good one,…but the company in question in the gumshoe article,…not so sure. There is speculation in the market at this point, that Smith and Nephew is a take over target by the larger companies,…Medtronic,…etc. and it’s price has risen in response by about 20% in the last 6 weeks.

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willran2
willran2
6 years ago

Travis–Thank you for the article.

👍 150
willran2
willran2
6 years ago

Dr. Bonz— Thank you for your insight.

👍 150

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