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SurModics (SRDX)

This medical device company hammered last quarter’s earnings estimates, but its biggest growth is ahead.

SurModics (SRDX)
From The Periscope Report

SurModics (SRDX) provides surface modification and In Vitro Diagnostic technologies to the healthcare industry.

The Medical Device segment offers surface modification coating technologies to enhance access, deliverability, and predictable deployment of medical devices, as well as drug delivery coating technologies to provide site-specific drug delivery from the surface of a medical device for the coronary, peripheral, neuro-vascular, urology, and other markets. This segment also engages in the development of percutaneous transluminal angioplasty balloon catheters for use in various interventional cardiology applications.

The In Vitro Diagnostics (IVD) segment provides component products and technologies that include protein stabilization reagents, substrates, antigens, and surface coatings for diagnostic immunoassay and molecular tests, as well as to the diagnostic, biomedical research, and life science markets.

Royalties and license fees represented 51% of sales in fiscal 2015. Licensed customers include Abbott Laboratories, Boston Scientific, Cook Medical, Cardinal Health, Medtronic, Edwards Lifesciences, and St. Jude Medical.

The CEO of SurModics said he will introduce at least three new products before 2020 that will change the face of vascular surgery because they use a lubricant that makes them easier to insert and navigate within the body, allow for drug delivery within the catheter, and a drug-coated balloon catheter that does not exist yet. These new products are for “unmet needs” and could quickly grow to dominate the market. These three products could easily have $150+ million in sales by 2020, or triple the current sales base at SurModics.

SurModics (SRDX) is headquartered in Eden Prairie, Minnesota, one of the hotbeds for medical technology in this country. SRDX spends 30% of revenue on R&D (more than twice any competitor) and it recently acquired two cutting-edge medical technology companies that positions the company for hyper growth in fiscal 2017 when it will start introducing at least one new product per year that could attain $50 - $200 million in revenue.

SRDX provides vascular catheters and balloon catheters for use in surgery. SRDX has developed a proprietary technology for its devices, which presents a huge barrier to entry. SRDX owns 151 issued U.S. patents and 195 international patents. In addition, SRDX has 83 pending U.S. patent applications and 112 foreign patent applications, which makes it the clear leader in its field.

SRDX is well capitalized for a small company, with $43 million in Cash, a Current Ratio of 9.5-to-1, and very little debt. This is good for two reasons. First, SRDX can fuel its own growth without having to raise any more debt or equity. Second, in addition to its proprietary technology, it makes the company a very attractive acquisition target.

The U.S. demand for in vitro diagnostic (IVD) products will rise 6% annually to $24.7 billion in 2016, up from $18.4 billion in 2013. The worldwide demand for IVD products is expected to reach $74.65 billion by 2020, up from $53.32 billion in 2013, or a growth rate of 6%. Geographically, Asia Pacific is the fastest growing region and very opportune market that would generate the highest revenue by 2020.

For the fiscal year 2016, management expects revenue to range from $62 - $66 million, with Non-GAAP earnings of $0.66 - $0.75 per share, down from $1.05 per share in fiscal 2015 due to acquisition costs and a higher tax rate. For the 1Q ended December 2015, total revenue increased 16% YoY to $16.5 million. On a Non-GAAP basis, Net Income increased 44% YoY to $5.0 million, up from $3.5 million a year ago, and net earnings improved to $0.38 per share, up from $0.26 per share a year ago, and up from $0.30 per share in the prior quarter. This clobbered the mean estimate for $0.17 per share.

Based on our Cash Flow forecasts, SRDX is greatly undervalued. Based on our forecasts for future Cash Flows, we believe the fair value for SRDX ranges from $55.73 to $60.57 per share, with a mid-point of $58, or 300% higher than the current stock price of $19.25.

SRDX has five analysts on coverage, which is unusual for a micro-cap company. Their mean earnings estimate for fiscal 2016 is $0.66 per share, or within management’s guidance. But things get interesting in fiscal 2017. The mean estimate for fiscal 2017 is $0.89 per share, but there is a wide range from $0.75 – $1.21 per share, which should be the first year of hyper-growth.

We are expecting sales to grow 3% in fiscal 2016 to $64 million, which is in line with management’s guidance. We are forecasting Net Income of $9.2 million, or $0.70 per share, down from $1.05 per share in 2015 due to a much higher tax rate. The P/E on the 2016 estimate is 14.7 times, which is moderate.

We are expecting sales to grow 30% in fiscal 2017 to $83 million. The net profit will grow 35% to $12.4 million, or $0.95 per share. The P/E on the 2017 forecast is cheap at 10.8 times.

Tom Byrne, The Periscope Report, 4025 Sunset Ridge Drive, Canyon Ferry Crossing, Helena, MT 59602, 406-465-4663, February 24, 2016