LeMaitre: Widened Capital Structure, Acquisitions Drive Top-Line Growth

Widened Capital Structure, Acquisitions Drive Top-Line Growth

LeMaitre Vascular (NASDAQ:LMAT) posted a strong sequential growth pattern on the exit of Q3, with particular strength from acquisition revenue and effective use of the balance sheet, widening the capital structure to be more debt inclusive. Shareholders have realised ~33% upside over the past 6 months, and we believe management has provided enough evidence on sequential drivers in the upcoming periods that must be reflected into the bullish commentary.

Figure 1. LMAT single-year chart

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Data Source: Author’s Bloomberg Terminal

On a backdrop of acquisition activity, strong sales performance in the recovery from the pandemic, in addition to a rebound in operating performance metrics, we feel the company presents as a value proposition investors should consider if seeking exposure to peripheral vascular therapy. Here we give investors a flash report of the key factors for consideration, demonstrating management’s newfound grasp over the capital markets, in addition to the near-term outlook.

Acquisition Integrations Have Been a Success This Year

The Artegraft acquisition has been an important part of the piece this year, after the company completed the part-cash transaction in July on a $90 million valuation. Artegraft sells biologic vascular grafts derived from bovine tissue, which are marketed under the brand name Artegraft, and have most direct application for haemodialysis access patients. The company generated around ~$34 million in sales in the 12 months leading to May this year, and saw unit sales growth of ~10% over 2019. This acquisition is a strategic move by management, and Artegraft operations tuck in nicely and complement the wider portfolio mix for the company. We believe that LMAT will continue to see upside from this transaction over the coming periods, particularly at the margin and operating level. To illustrate, the bovine grafts segment for LMAT grew ~$5.5 million YoY, underscored by the Artegraft transaction.

The company also acquired additional peripheral vascular assets, obtaining commercial and profit rights to the CardioCel biologic patch from Admedus (ASX:AHZ) on a valuation of $15.5 million. LMAT balances the pricing risk in this situation, via the licensing structure that sees AHZ retain the manufacturing of CardioCel for the next 3 years (until LMAT fully transitions operations over to the US). The company also gains rights to the VascuCel biologics patch as well, and both systems are processed in a way such that the risk of calcification is dampened, ultimately improving patient outcomes after peripheral vascular surgery. Sales of both surmounted to $7.1 million in 2019, and have grown ~$1.1 million YoY according to management on the earnings call. Keep in mind the headwinds that all peripheral vascular vendors have faced this year on the back of COVID-related closures of procedures and backlog of consultations in medical facilities, and the deferral in procedures that have surmounted on the back of this.

Management has acknowledged the significance of these acquisitions as key drivers to growth at the top, and we feel that more acquisition activity is likely on the horizon. The company left the quarter well-capitalised, with ~$35 million in cash, ~$9 million increase YoY, such that they were able to pay down ~$4.5 million of the debt financing used in the Artegraft transaction. This reduced the debt balance to just under $17 million. Additionally, strength in cash from operations realised cash flow of ~$14 million, driven mainly by the acquisition activity and recovery in procedure volumes in the US and China. Management also sees the benefit in widening the capital structure to include more debt on the balance sheet, which has been largely conservative over the recent years. The total debt load increased from ~$13 million to $52 million by the 2nd quarter, in preparation for the acquisition activity outlined above. However, the interest expense remains well covered from EBITDA level earnings at over 19x coverage, and the debt ratio remains just under 20% despite the ramp up in leverage. Furthermore, equity to assets remains at 61%, having come down from ~83% YoY, illustrating the spread away from financing risks in spite of the increased debt load. As such, the company remains under 3x leverage, and total debt to capital is around 32%. These are healthy figures in our view, and give weight to the potential in further debt financing that can be used to increase the scope of acquisition potential.

Operations Are Well on The Recovery

China has just about wiped their COVID-19 slate clean, which has helped drive revenues in the back end of this year for LMAT. Prior to this, the company lost patient turnover from incomplete follow-ups that were recognised back in 1H 2020. This meant at least half to 75% of the tail on revenue streams from service delivery was effectively sliced away, and now the company has made a strong sequential recovery with these follow-ups built back into the cash flow statement. So much is true in many geographical zones, which are now seeing a reopening of health institutions like hospitals and clinics, to LMAT’s benefit. Revenues came in above consensus for Q3 at $36.4 million, a 25% YoY increase, underlined by total acquisition revenue of ~$7.6 million. Operating income of $10 million increased 70% YoY, compounded by a net reduction in OPEX of ~11% YoY at ~$13 million. Acquisition activity certainly helped drive this upside over the recent quarter. Artegraft alone generated ~$5.5 million, and just under $1 million in operating income on the same. Management has guided ~$5.6 million in Artegraft sales for Q4, in line with the sequential growth pattern we’ve seen in the back end of 2020. Additionally, integrations of Omniflow II and Syntel were completed at the end of Q2, helping to drive operating performance this recent quarter.

Gross margins faced headwinds of ~600bps YoY, which was marred by manufacturing inefficiencies and the purchase accounting for Artegraft. Operating margins were at 28%, and management is confident of some return to gross margin normalisation towards ~66% in Q4, as things begin to stabilise and accounting activity from the 2020 transactions begins to normalise also. Accounts receivable turnover increased by ~2.5% to 7.90x from Q2, whilst days of sales outstanding decreased by ~2 days to 51 days. The company gained traction on inventory turnover back above 1x, with days inventory outstanding reducing by ~28 days to 359 days. Furthermore, accounts receivable turnover managed to increase back to over 13.8x, more in line with pre-pandemic figures. Therefore, the cash conversion cycle reduced by a meaningful 38 days to 397 days, coupled with a similar decrease in the inventory to cash period. Therefore, operations are well on the recovery back to pre-pandemic levels, and the integrations and acquisitions have started to come through the income statement, resulting in improvements to operating efficiency and ultimately cash generation.

Figure 2. Operating Efficiency Q1 2019- Q3 2020

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Data Source: LMAT SEC Filings; Author’s Calculations

Valuation

Shares are trading at ~31x FCF, on a FCF yield of 3.51% with $0.67 in free cash per share. The company also has ~$1.70 in cash per share, $7.93 in book value per share and $34 in EV per share. The market has high expectations for the company, indicated by 107x forward P/E consensus, well above historical averages and most likely backed by the high ROIC that the company has managed to maintain over the recent periods, in particular reference to the acquisition activity seen this year. ROIC has remained above 8-10% over the previous 7 quarters, and we believe the company will leverage the efficiency here to see the upside on the transactions completed this year, which are only in the birthing stages mind you. ROIC has driven at least 40%-55% of valuation multiples, and driven at least 33% of free cash conversion over the recent periods. Additionally, ROIC has driven ~72% of capital allocation decisions over these periods also, thereby serving as a good indicator for additional transaction activity over the near-term.

Figure 3. High ROIC drives key valuation and outcome measures

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Data Source: LMAT SEC Filings; Author’s Calculations

Shares are also trading below 2-year historical averages at 32x P/E and ~18x EV/EBITDA, ~6%-12% discount, respectively. This makes the valuation attractive, particularly on the operating performance of the company this year. There is potential that shares may converge to the upside on this picture, and we would advocate investors to consider entry based on these valuations, that are backed by strong ROIC and solid governance principles that continue to drive longevity in shareholder value.

Figure 4. Shares are trading at discount to historical average multiples

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Data Source: Author’s Calculations

Investors can see the potential in pricing outcomes should shares continue along the current level of support on the chart below. We feel this is important information for longer-term investors wanting to make decisions on entry and exit points over the coming quarters. We can see the upside potential based on the pricing distribution outcomes that may arise at the current level of support, which seem to align with the overall growth thesis of management. Therefore, we encourage investors to familiarise themselves with the chart below, in order to make the most informed reasoning possible.

Figure 5. Pricing Distribution Outcomes

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Data Source: Author’s Bloomberg Terminal

Further Considerations

On the charts, shares have trended in an ascending channel with clearly defined support since the March selloff. Price dispersal has snaked tightly around the mean return, shown by the red line in the regression channel on the chart below. Shares have bounced away from support at least 5 times over this period YTD, but have not yet broken the upper resistance ceiling on the ascending channel. Shares have also displayed a great deal of mean reversion activity YTD, having reverted towards the mean 13 times since March. Shares are currently below the mean return level, indicating that the potential next moves may be back north, thereby indicating potential entry points on this basis. In fact, based on this activity YTD, investors may continue to reallocate on weakness, adding to positions when pricing outcomes slide in below the mean return, as shares continue their overall climb northward. Based on this activity YTD, we firmly believe that the current investor sentiment is bullish, and feel this sentiment will likely continue into the mid-term as acquisition targets begin to feed into income statement and cash situation.

Figure 6. Pricing Distribution YTD

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Data Source: Author’s Bloomberg Terminal

In Short

LMAT has potential to widen the upside potential in shareholder value based on strategic acquisition activity this year and improved operating performance. Both should translate towards top-line growth patterns over the coming periods. We believe that valuations are attractive at current multiples, trading at a decent discount to historical averages. Additionally, the company has realised solid cash efficiencies this year on the back of an improved balance sheet, which has been put to effective use by widening the capital structure to be more debt inclusive. Coupled with the historical ROIC performances over the recent periods, we believe the company will continue to deliver the upside on this basis. As procedure deferrals make a rebound in unison with patient volume recoveries as the pandemic diminishes, LMAT will likely gain traction in bovine graft distributions with CardioCel turnover tied into the mix, amidst other portfolio segments, well into the back end of 2021, in our view.

Shares have continued there uptrend in the ascending channel formed since March, with strong support and repetitive mean reversion activity that has propensity to reproduce in the near-term. We believe that shares are trading at a discount as mentioned at 32x P/E and 18x EBITDA, and the market has big expectations for the company with forward P/E estimates of 107x. We believe that LMAT has the room to converge to the upside, and that investors should consider entry at current valuations if seeking exposure to peripheral vascular therapy. We look forward to providing additional coverage at the back end of Q4 2020.

Disclosure: I am/we are long LMAT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Credit: SeekingAlpha

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