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Robert Abbott
Robert Abbott
Articles (777)  | Author's Website |

Boston Scientific: Fast-Growing Earnings Get the Attention of Gurus

For those who can come to terms with its debt load, this medical device company offers a strong upside

May 19, 2020 | About:

What stocks are most popular among the gurus, the investing giants after whom GuruFocus is named?

To find out, we can turn to the S&P 500 Screener, which lays out where they have committed their money recently. In mid-May 2020, the top position was held by National Oilwell Varco (NYSE:NOV); moving down the list to the number four position, we find Boston Scientific Corp. (NYSE:BSX).

According to its 10-K for 2019, Boston Scientific is “a global developer, manufacturer and marketer of medical devices that are used in a broad range of interventional medical specialties.” It sells its products through seven divisions: Interventional Cardiology, Cardiac Rhythm Management, Endoscopy, Urology and Pelvic Health, Peripheral Interventions, Neuromodulation and Electrophysiology.

It rose to near the top of the gurus’ net buy list with 15 purchases versus seven sales, for a net buy of eight, and not that far behind National Oilwell Varco’s 10 net buys.

What’s the attraction? For starters, let’s take a look at its revenue and its diluted earnings per share over the past 10 years:

Boston Scientific revenue and earnings per share chart

Those numbers reflect Boston Scientific’s share price over the same period:

Boston Scientific 10-year price chart

While it’s been a bumpy ride, the share price rose steadily between the beginning of 2013 and February of this year. After that, the price tumbled as many elective procedures were postponed because of the Covid-19 crisis.

In his shareholders letter for 2019 (dated March 10), Chairman and CEO Mike Mahoney reported the company had built on the stream of accomplishments that began five years earlier:

  • Organic sales grew by an annual average of 7% per year.
  • The adjusted operating margin increased by 3.8%.
  • Adjusted earnings per share grew by an average of 14.4% per year.
  • The stock price rose 28% in 2019, comparable with the total return from the S&P 500 index.
  • With a five-year return of 241% and a three-year return of 109%, Boston Scientific more than doubled the S&P 500’s total returns.

The company, with a history of buying up other companies, made two major acquisitions in 2019. One was the British firm BTG PLC, at a price of $4.2 billion; the other was Vertiflex for $465 million. The BTG deal is expected to be accretive in 2021.

To be an acquirer, a company also must be a strong generator of cash flow. It must cover its various costs, its dividends for shareholders (Boston Scientific does not pay a dividend) and cover capital expenditures ($461 million in 2019) to organically grow or maintain its businesses. Whatever is left over is available for acquisitions.

Funds for research and development also come out of cash flow; Mahoney reported in the shareholder letter that Boston Scientific spent more than $1 billion on R&D in 2019. During the year, the company introduced more than 85 new products. And, importantly, for a medical products company, it also received “significant” regulatory clearances.

That level of R&D, on an ongoing basis, is likely to generate new products for years to come. With each new product come new revenue and earnings opportunities.

Demand for new and existing products is likely to grow as physicians treat increased numbers of elderly patients with chronic conditions. The first wave of the baby boomer generation is now in their 70s, an age at which more and more medical services and procedures are needed.

Mahoney wrote, “As we move into the next decade, we face challenges from the growing burden of chronic conditions among an aging population, the demands of value-based care and new, disruptive competitors. These trends also represent opportunities, and I am energized and inspired by the significant advancements we have made and will continue to make, and by the lives that have been extended or enhanced because of our products.”

From an investor’s perspective, demographic knowledge is a rare commodity. Few things about the future are certain, but the age and sizes of various demographic cohorts can be projected with relatively strong confidence. It enables both investors in the medical and funeral sectors to eliminate some uncertainty or to turn some uncertainty into risk (which can be measured).

Unfortunately, that does not help us with valuations of Boston Scientific because its earnings have been unpredictable over the past five years (it receives a one out of five-star rating for predictability). Still, the price is currently depressed and appears to offer at least some margin of safety.

Investors will not get much guidance from its financial strength rating:

Boston Scientific financial strength

A primary reason for the mediocre rating is the way it has piled on debt in the last couple of years. New debt in 2018 and 2019 amounted to $4.77 billion, which was the same amount it spent to buy Vertiflex and BTG.

That’s a lot of new debt, but at the same time, Boston Scientific has been growing its return on equity rapidly:

Boston Scientific return on equity chart

Alberto Abaterusso recently reported on stocks with fast-growing earnings, and Boston Scientific topped that list.

The three gurus with the largest holdings are PRIMECAP Management (Trades, Portfolio) with 42.3 million shares, the Vanguard Health Care Fund (Trades, Portfolio) with 32.2 million shares and Andreas Halvorsen (Trades, Portfolio) of Viking Global Investors with 31.8 million shares.

This table shows the relatively strong interest in Boston Scientific since its share price dipped:

Boston Scientific guru buys and sells

Conclusion

With this new debt and new acquisitions to digest, Boston Scientific faces some headwinds. But it also has demographic and operational strength as tailwinds, helping to generate robust earnings that are likely to last for quite a few years. As a major spender on R&D, it has a significant pipeline of future products as well as patent and regulatory protection for much of its product line.

While we do not have a DCF analysis to guide us, we do know the share price has gone down significantly, and if the previous price trend is any indication, there is currently a margin of safety.

Many value investors will turn away because of the debt load, but at least some of the gurus see more opportunity than trouble. That confidence is likely based on the tailwinds noted, the strength of its growing earnings and its price.

Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


Rating: 4.0/5 (1 vote)

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Comments

Praveen Chawla
Praveen Chawla premium member - 2 weeks ago

Thanks for the article. Another area to check is that even though earnings are up, cash flow is not.

Robert Abbott
Robert Abbott premium member - 2 weeks ago

Thank you, Praveen!

innkiss
Innkiss - 1 week ago    Report SPAM

Thanks for the post

Robert Abbott
Robert Abbott premium member - 1 week ago

You're welcome, and thank you for letting me know!

Please leave your comment:



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