Cabot’s “$17 Stock to Turn $34” Medical Device Stock

by Travis Johnson, Stock Gumshoe | August 22, 2016 10:51 am

Timothy Lutts' ad for Cabot Small Cap Confidential says: "This Medical Devices Company is About to Double Again" -- what is it?

This ad caught the eye of several readers, and it’s a slight variation on an ad that I first solved for the Irregulars back in June — so I thought I’d give it a quick once-over and see if we’re still talking about the same stock. So, my dear Irregulars (those are our paid members, in case you’re wondering), this might not be all that new for you… let’s see.

Here’s the opening, which is a pretty strong pitch — and we should pause to give Timothy Lutts[1] and his copywriters credit, because it’s a pitch based on the fundamentals of the stock. It’s not a made-up story about some revolutionary idea or technology that doesn’t exist yet:

“The medical devices company I’m about to name will soon be a $34 stock that you must snap up today for $17.

“The stock jumped 25% in the last 30 days and is set to jump again.

“The company specifically targets a niche market in cardiovascular disease[2] where it has a monopoly-like market share.

“This is why the company has delivered four positive double-digit earnings surprises in a row … why seven analysts upped their earnings estimates in the last 30 days … and why its price has risen 132% over the past two years.”

Of course, they get a bit silly, too, comparing it to Tesla (TSLA) — but that’s pretty much in the ad template for them, they compare each growth stock to some former idea of there’s that has doubled and hint that their next idea is “like Tesla, only better” or “revolutionizing the medical industry like Monster revolutionized soft drinks” or “riding a wave of unstoppable growth like Amazon.”

So like most of their promoted profit analogies it sounds a bit strained, but here’s how they put it today:

“Just as Tesla’s battery[3] breakthrough revolutionized the electric car industry, this small cap medical juggernaut is doing the same thing for the surgical treatment of cardio vascular diseases (CVD).”

That sounded very familiar, despite the fact that their ad implies that this is a fresh recommendation (they want you to get in before the stock goes up, which they say often happens soon after they pick a stock)… so then I checked a few of the other clues, and yes, this is indeed the same stock they were teasing on June 10. So here’s the rundown of those clues for those of you who missed the first article (some of this is taken from my June 10 Friday File[4], though I’ve done some updating).

“… the bulk of our company’s surgical profits will be paid for by the government—AND the shareholders will reap massive profits along the way.

– A huge percentage of the 77 million Americans who turn 65 over the next 18 years will ultimately require these kinds of heart-saving treatments, as heart disease is one of the leading age-related illnesses in America, and the fact that
– Medicare insurance will shell out billions to pay for them.”

OK, but that’s true of any medical device or pharmaceutical company — people don’t pay for these things out of pocket (if they did, the economics of our healthcare[5] system would be dramatically different… with a lot more customer service and competition, and a lot less filling out of forms by both doctors and patients).

So how about some specific clues? He doesn’t give a lot, but this is what we have to feed to the Thinkolator…

“This small-cap company’s surgical technology solution offers less discomfort and quicker recovery than traditional methods….

“The company is clearly the leading provider in its sector not only with a 30-year history in the space but also a whopping 79% market share….

“Shareholder—friendly and expert management has already handed investors nearly 100% gains over the past two years and looks to repeat this performance every two years for the next decade or so—all thanks to its growth platform that targets 10% annual sales growth and 20% annual profit growth.”

This “secret” stock is actually showing more than a 100% gain over two years as of today, but that hint was accurate a few months ago when they wrote the ad. A little more, please?

“… it may also be the perfect takeover candidate, thanks to its $79 million in revenue, current 58% revenue growth and monopoly-like position in this growing field.”

And while we had a small bit of uncertainty last time around — this time we also get the “$17 stock” part of the hint, which is new, so we can tell you that the Thinkolator’s answer was (and is) almost certainly correct: This is LeMaitre Vascular (LMAT)[6]… which, in some ways, is in a similar business to a couple of other “vascular” companies Cabot[7] Small Cap Confidential recommended under their previous editor (ELGX in 2012[8] and CSII, which they then called their “stock of the decade”, in 2013[9] — both failed to hit their promoted mega-returns), LMAT is much more of a diversified “platform” growth company that’s trying to roll up lots of little niche businesses and “own” the vascular surgery[10] space, particularly disposables and implanted tools, with a strong sales force and a variety of products.

Why is this the match? LeMaitre’s latest investor presentation[11] (which has some good data, by the way, worth a look) includes the quote “We aspire to achieve 10% sales growth and 20% profit growth.” So that’s one check mark.

And they did have $79 million in revenue in 2015… though one little hiccup is that they didn’t have 58% revenue growth. They DID have 58% net income growth in the first quarter this year, so I suspect that’s either an intentional or accidental fudge from Laundon’s ad copywriter.

The growth has been continuing — the trailing twelve months revenue number is now up to $82 million, and the last earnings report helped to bump the shares up from the $14 range to the $17 range… so the stock has gone up roughly 25% in the last month (depending on which exact dates you use). They beat earnings estimates in that quarter, and projected that this year’s sales would end up at over $88 million, so that’s 11% year over year revenue growth… and they also increased their income forecast for the year — so it was every growth investor’s favorite kind of quarter, the “beat and raise.”

And while I don’t know that they have 79% market share in any particular segment (that data is always a little squishy anyway, and it depends who you ask and what they’re counting), but they do have a slide in their presentation indicating that they make 79% of their sales calls to vascular surgeons and focus on that market almost exclusively and try to “own” it. That’s not the same thing as “market share”, but perhaps it’s where they came up with that number.

LeMaitre Vascular was started a little over 30 years ago by George LeMaitre, a vascular surgeon who had an idea for a better tool and decided to try to sell it to his colleagues. He is still Chairman and CEO of the company, and still owns almost 20% of the outstanding shares (though he’s a pretty consistent seller of shares, there has been no insider buying[12]). They have remained completely focused on serving vascular surgeons, developing some new tools through R&D along the way and acquiring many more — that level of specialization presumably gets them more attention from those vascular surgeons who make decisions about which products to use for their surgeries, and LeMaitre is very focused on being a direct seller to those surgeons. They have consistently increased their direct sales force, and by the end of the year they say they’ll have 96 salespeople selling direct in 21 countries. Each new product, at least in theory, improves efficiency because it gives that sales force something additional to sell.

I don’t know whether their products are markedly better or different than their competitors’ offerings, but they must be doing something right — their gross margins are 70%, which is quite impressive (meaning that the direct cost of making and delivering a $100 tool is only $30), so even if the competition is significant for some of their products it’s not hurting their ability to sell profitably. Lately, the growth has largely been coming from their biologic products (grafts and such) more than the tools, and they’re looking to grow both in that area and in endovascular products and tools.

You can see the latest quarterly conference call transcript here, from late July[13]. It’s a pretty ebullient quarter for them, since they hit all kinds of records, but one interesting note is that they’re getting a big boost from a competitor’s problems right now — Baxter had to recall one of their biologic products, so LeMaitre says they were already receiving a sales boost from that, and that’s probably part of the reason for their increased forecasts (biologics, led by their fast-growing XenoSure graft, are more than 25% of revenue now). They were growing anyway, but that is providing some boost.

The stock continues to look quite interesting to me, even though it’s now more expensive after that “beat and raise” quarter (I was interested after I wrote about it in June as well, though did not personally buy it — to my current regret). The valuation is a little bit steep but perhaps reasonable if they can really hit those 10% revenue/20% profit growth numbers every year, and they are likely to do far better than that this year.

Analysts were forecasting numbers slightly lower than that back in June (like 8%/20% this year), but they’ve been forced to raise their estimates after the strong second quarter. The stock trades now at about 31X current year expected earnings, or 28X next year’s earnings forecast, and they’ve beaten the earnings estimates quite handily for four quarters in a row now. That’s a fairly steep valuation, but they do have what looks like a pretty strong niche, and they seem confident that they have a pretty strong pipeline of possible small acquisitions that they can continue to make — their goal is to make an acquisition every year and to release a new internally designed product every year, and as that goes out to their very focused sales force the revenue growth pours in (or that’s the plan, at least).

The balance sheet is fantastic — they have $29 million in cash, which makes a nice war chest for acquisitions of the size that they’ve typically made (many of them are just a couple million dollars or less), they have no debt, and they pay a small but growing dividend (about a 1% yield, but they’ve raised the dividend every year for five years). And it’s quite a small company, with a market cap of $315 million. Having a good balance sheet and making acquisitions without having to sell stock or borrow money can produce meaningful compounding over time — cash profit is spent on R&D and acquisitions, which increase the cash profit, which is spent on more growth… so mostly what you have to have faith in is that they will get more acquisitions and new product introductions right than they get wrong (they’re open about this in that investor presentation[14], noting their “win-loss” rate for products).

It’s hard to buy a company that’s got a bit of a premium valuation like this and isn’t necessarily going to register show-off nosebleed growth like your latest tech stock darling, and I don’t know when they might see a lid put on their growth by better competition, or by failure to innovate more quickly than older products go stale, but I like the growth by aggregation model when you can do the acquiring by reinvesting your profits — and it looks to me like the niche products they’re buying become much more valuable in their hands than they were previously, thanks to the improved market access they can provide with their direct sales force. And they certainly proved that there’s room for more growth than analysts had been expecting… so I remain tempted by this one, though now I’m writing about it again so I can’t buy it for a while (which might be a good thing, since there likely won’t be any big news for a while out of LMAT and the stock may have a chance to drift a little lower).

That’s just my take though — it’s your money, so what do you think? Will Lutts and Laundon have a big winner here for Small-Cap Confidential[15]? Too expensive for you? Worried about something I haven’t mentioned in LMAT? Let us know with a comment below.

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