K2M Shores Up A Weak Spot For Stryker

One of the best med-tech names out there, Stryker (SYK) doesn’t have many weaknesses, but the company’s spine business has been one notable exception. With a portfolio that has been lacking in innovation or differentiation, Stryker has seen its market share in spine drift lower against the likes of NuVasive (NUVA) and Globus (GMED) in recent years. Acquiring K2M (KTWO) is a strong step in shoring up the weakness of Stryker’s spine business, and while some investors may question Stryker’s decision to “double down” in a tough business, the long-term benefits of the move could be larger than they first appear.

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K2M Shores Up A Weak Spot For Stryker

K2M Gets A Boost From A Stronger Spine Market

Investors have been doing some bargain-shopping lately in the spinal care space, as these stocks have largely lagged a strong med-tech market due to ongoing concerns about weak U.S. volume growth and persistent price pressure. That bargain-shopping got a nice boost with second quarter earnings, as all but one of the four major independents (K2M (KTWO), NuVasive (NUVA), Globus (GMED), and SeaSpine (NASDAQ:SPNE)) saw a 10% or better pop on June quarter earnings (Globus being the exception, but that stock had been on a tear up into June).

I’m still a little concerned about the overall level of valuation in the med-tech space and the risk that spine procedure volume growth could disappoint again, but I also still like K2M. Although the company’s focus on complex/deformity helps to shield it somewhat from volume and price pressures, I also like the company’s expanding sales force and product line-up, as well as the potential for margin leverage as it scales up its operations. Although the shares are no bargain by discounted cash flow, they do appear to be trading at a lower forward revenue multiple than the growth rate would otherwise suggest is fair.

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K2M Gets A Boost From A Stronger Spine Market

K2M Disrupting The Market, Growing, And Still Undervalued

Innovation can still produce results even in a sluggish U.S. spine market, as seen with the ongoing growth at companies like K2M (KTWO) and Globus (GMED). In the case of K2M, the story is still about the company's disruptive product development in degenerative and complex spine, supported by a strong platform in 3D-printed implants. With that, the shares have done okay since my last update - rising close to 10%, which is not as good as Globus, but pretty good next to other med-techs in the spine space like Stryker (SYK) and NuVasive (NUVA).

I continue to believe that K2M shares are undervalued. The company's liquidity and cash flow situation is not ideal, but spending money on product development and competitive rep hires to support those product launches makes sense, and I believe the company will get to double-digit FCF margins within five years. With that, I'd consider buying into the mid-$20s.

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K2M Disrupting The Market, Growing, And Still Undervalued

NuVasive Not Getting, Or Deserving, The Benefit Of The Doubt Yet

Investors remain reluctant to give NuVasive (NUVA) much benefit of the doubt, and based upon the company's recent performance, I can't say I blame them. Although I wrote back in January that I thought it would take time for the company to rebuild investor confidence, I'm still surprised to see the nearly 10% drop in the share price over that period, while Globus Medical (GMED) has shot up nearly 20% and K2M (KTWO) has risen close to 10%.

There are a lot of issues with NuVasive right now, including a fairly spotty history of earnings quality, worries about competitors poaching away reps, and signs that NuVasive's new products aren't producing the same growth leverage as before. What's more, as NuVasive has grown to become a bigger player in the spine market, it's harder and harder for the company to separate itself from the challenges in the market.

Valuation is tricky. On a cash flow basis, the expected return isn't as high as I'd like to see given the risks. On the other hand, med-tech doesn't often trade on cash flow and the shares do look undervalued, perhaps significantly so, on an EV/revenue basis. There's some appeal here as a turnaround story, but NuVasive will be granted little quarter or patience by the Street if results don't start meaningfully improving.

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NuVasive Not Getting, Or Deserving, The Benefit Of The Doubt Yet

K2M Looking To Move Past A Disappointing 2017 With Innovation-Fueled Growth

The last year, and especially the last six months or so, hasn't been very friendly to the pure-plays in the spine space like K2M (KTWO) and NuVasive (NUVA), and though Globus (GMED) has had no such problems. In the case of K2M, this company's focus on complex and degenerative cases hasn't spared it from some of the same overall pressures that have hit the sector, and the shares were down about 15% from the time of my last article before a recent rally shrunk that underperformance a bit.

Although K2M's recent underperformance is a little concerning, the company still has a strong line-up that should drive better results in 2018 and beyond. Competition remains a risk, but K2M has brought innovation to a space that has generally been overlooked and that has helped serve as a "force multiplier" for the sales effort of this relatively small company. While I wouldn't buy (or recommend) a stock on the basis of M&A potential, K2M looks like an attractive digestible target, but the shares have enough standalone upside to justify a closer look.

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K2M Looking To Move Past A Disappointing 2017 With Innovation-Fueled Growth

A Window Has Opened For NuVasive

Writing on NuVasive (NUVA) three months ago I said, “Given the history here of the market swinging too far during both the bad times and the good times, I'd be careful buying near the highs, but I'd certainly reconsider if the sector sells off on another bout of health insurance reform uncertainty and/or a company-specific shortfall in earnings/guidance.”

One of those big swings has occurred, with the shares down a quarter since then. The decline hasn't come without some reasons, including a slower U.S. spine market, executive departures, and a subpoena from the OIG, but these don't strike me as long-term issues. Instead, they remind me of a lot of the other short-term setbacks that have created interruptions in NuVasive's long-term run. To that end, I believe strong revenue growth and margin leverage are still in play here, and I believe the shares are actually undervalued.

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A Window Has Opened For NuVasive

Globus Medical Has Wobbled A Bit, But Still On Good Footing

Since I last wrote on Globus Medical (GMED) in March of 2016, “second tier” spine names have enjoyed a good run. K2M (KTWO), which I've liked more than Globus, is up a strong 85% and NuVasive (NUVA) is up more than 60%, but Globus too has rewarded my belief that it was undervalued with a roughly 46% upward move in the shares. What's more, given that Globus didn't exactly cover itself in glory in 2016 with respect to its organic revenue growth performance, I believe at least some of this move is a sector-wide shift toward a more positive view on the spine market and share-takers within that market.

Looking ahead, I don't see Globus as particularly cheap, but that's an increasingly common issue. I think Globus is back on track with respect to performing in line with its guidance, but I do worry that management could be stretching itself a little thin between its core spine business, its foray into robotics, and its new trauma business. I do still see opportunities for Globus to grow and gain share and it's not a bad hold at these levels, but I'd be tempted to wait in the hope of a pullback before building a substantial new position.

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Globus Medical Has Wobbled A Bit, But Still On Good Footing

K2M On Track, Gaining Share, And Continuing To Disrupt

Spine care company K2M (NASDAQ:KTWO) isn't going to be the easiest stock to own, as I expect investors to overreact to quarterly revenue trends and guidance, and I fully expect some bumps in the road as the company continues to launch and grow a portfolio of disruptive technologies for the spine care market. I also expect ongoing growth, though, as the company out-innovates its larger rivals, takes share, and ultimately leverages that into solid profits.

The shares are up about 20% since my last update, sandwiching the company between the outperforming Globus (NYSE:GMED) and underperforming NuVasive (NASDAQ:NUVA) over that time. Trading in the low $20s, the shares still look a little undervalued on the basis of medium-term revenue growth and margin outlook and look relatively appealing up to around $25. Although that doesn't leave a tremendous amount of upside from today's level, I would not be surprised if K2M outperformed, and I would keep this name in mind if the company's early May earnings report sees an overdone negative reaction.

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K2M On Track, Gaining Share, And Continuing To Disrupt

Consistent Excellence Continues To Drive Stryker Higher

Institutional investors don't like surprises (at least the negative ones), and they adore above-average growth. That puts Stryker (NYSE:SYK) right in their sweet spot, and it goes a long way toward explaining why the shares often trade at a premium. These shares are up another 15% from the time of my last update, and the company's growth rate continues to impress. While Stryker does not look undervalued today, it seldom does, and ongoing high-end execution should be able to at least maintain the valuation multiples.

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Consistent Excellence Continues To Drive Stryker Higher

NuVasive Has Restored Its Growth Cred And Has Been Well-Rewarded

While I did say that I thought NuVasive (NASDAQ:NUVA) was undervalued when I last wrote about this growing spinal care specialist, I didn't think a 40%-plus run in six months was on its way. But with ongoing share growth, margin improvements, incremental M&A, and clear signs that the company's comprehensive strategy is working in the market, investors have gotten back on board in a big way.

I don't want to be a wet blanket, but I do wonder if the excitement has gotten a little overheated. My expectations for 2020 have gone up close to 10% (and are still below management's targets) and the company could be set up to gain even more share in the deformity market and in the degenerative market with a move toward bundled payments. Still, I'm hesitant to stretch my valuation assumptions beyond what has historically worked for growth med-tech.

There's a pretty clear pattern with this stock - investors get excited, there's a notable pullback, a flattish period, another run, and then another pullback. The shares are still up almost 300% over the last five years, though, so that's volatility that I think many investors can learn to live with. I want a better risk/reward trade-off before I put my own money here, but NuVasive is definitely making hay today by exploiting a lack of innovation at entrenched rivals like Johnson & Johnson (NYSE:JNJ) and Medtronic (NYSE:MDT).

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NuVasive Has Restored Its Growth Cred And Has Been Well-Rewarded

Despite A Setback From Its OUS Distributors, K2M Continues To Leverage Innovation To Grow

K2M (NASDAQ:KTWO) is up about about 15% from when I last wrote about the company, but it hasn't been a smooth path. The shares were hammered in early May when the company lowered guidance due to business setbacks with two distributors that make up more than half of its international sales. Despite this blow, K2M has shown in the meantime that its innovative portfolio of products for complex/deformity, minimally invasive, and degenerative spine surgery can drive worthwhile growth in the U.S. market.

I continue to believe that K2M can and will grab share from Medtronic (NYSE:MDT) and Johnson & Johnson (NYSE:JNJ) in the complex/deformity market segment on the basis of innovation, and that the company will have success in pulling through into the minimally invasive and degenerative markets. I'm looking for low double-digit revenue growth over the next decade and for FCF margins to ultimately reach the low-to-mid teens. Factoring in the near-term setback to revenue growth (and its impact on margins and cash flow) and dilution from a recent convertible bond offering, my fair value drops to around $20, making K2M an okay idea for new money and at least deserving of a spot on the watchlists of investors interested in growth med-tech.

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Despite A Setback From Its OUS Distributors, K2M Continues To Leverage Innovation To Grow

Seeking Alpha: K2M Gaining On Entrenched Rivals In An Overlooked Space

All of the smaller players that have done well in spine care - NuVasive (NASDAQ:NUVA), Globus (NYSE:GMED), LDR Holding (NASDAQ:LDRH), and K2M (NASDAQ:KTWO) - have done so largely on the basis of being more nimble and more innovative than entrenched competitors like Johnson & Johnson (NYSE:JNJ) and Medtronic (NYSE:MDT). Although the market hasn't been showing a lot of love to the riskier small med-tech names of late, K2M looks like a name for more aggressive investors to investigate.

K2M has established itself as a viable rival in the complex spinal deformity market (scoliosis, trauma and tumor) and has had some success already in transferring its innovative technologies to the minimally invasive (or MIS) and degenerative spine care markets. Although this company needs to work on its margins and may not generate the sort of eye-popping revenue growth that some growth investors demand, I believe the shares look undervalued on the assumption of long-term growth in the low double-digits.

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K2M Gaining On Entrenched Rivals In An Overlooked Space