Surmodics Inc.: Buy, Hold, Or Sell? – Surmodics, Inc. (NASDAQ:SRDX)


Since my last article on Surmodics (SRDX) in March 2018, the stock has seen quite some movement. It rose from $33.95 on March 9, 2018, to $80.35 on September 13, 2018, and then fell back to $47.26 on December 31, 2018. And despite the drop, I consider Surmodics, the global leader in the medical device coating industry, to be an attractive investment opportunity even in 2019.

In its latest earnings conference call, Surmodics has updated its fiscal 2018 revenue guidance from the previously projected $75 million-$79 million to $79 million-$81 million, backed by better-than-anticipated revenue performance in the first nine months of 2018. Then, the company narrowed its fiscal 2018 loss per share guidance from $0.20-$0.35 to $0.25-$0.30, attributable to a charge of $0.47 per share associated with the acquisition of IPR&D from Embolitech acquisition. The company is persistently moving towards its long-term target of double-digit revenue growth by end of 2019 and EBITDA margins at or above 30% by the year 2021.

Today, Surmodics is in the process of transforming itself from just being a provider of coating technologies to one offering whole-product solutions that can target the interventional vascular segment, worldwide.

In this backdrop, I believe that Surmodics is a very promising investment option in 2019. In this article, I will be explaining my investment hypothesis in greater detail.

Commercialization agreement with Abbott Laboratories holds much promise for Surmodics

In February 2018, Surmodics entered into an agreement with Abbott Laboratories (ABT), whereby the latter holds exclusive worldwide commercialization rights for Surmodics’ SurVeil drug-coated balloon to treat the superficial femoral artery. In return, Surmodics will be receiving $25 million upfront payment and additional payments worth $67 million for various product development milestones.

Abbott also received options to negotiate agreements for Surmodics’ below-the-knee and arteriovenous (AV) fistula drug-coated balloon products. Finally, in accordance with the agreement, the two companies will also collaborate on product development, clinical trials, and regulatory activities to obtain marketing approval in the U.S. and Europe.

The agreement with Abbott Laboratories has been a major breakthrough for Surmordics. In addition to securing a revenue stream for Surmodics, this deal is a validation of the science backing Surveil DCB, which is currently being evaluated in the TRANSCEND trial.

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As per Surmodics’ fourth-quarter earnings conference call, Abbott expects Surveil DCB to report solid uptake due to its proprietary drug-excipient formulation which ensures a durable balloon coating and higher coating uniformity. Preclinical data for Surveil DCB has already demonstrated higher target tissue drug concentration, a more distributed and durable drug effect and lower incidence of downstream drug particulate as compared to earlier generations of a drug-coated balloon. In this backdrop, the complementary nature of Surveil DCB with Abbott’s other vascular care products, as well as Abbott’s extensive geographic reach, is expected to help boost the penetration of the product in future years.

Surmodics has been focused on its R&D programs to leverage the underserved opportunity in the PAD segment

The peripheral arterial disease (or PAD) affects almost 202 million people worldwide and is a market opportunity worth almost $2.0 billion.

According to the company’s investor presentation, Surmodics estimates that more than 500k patients undergo procedures for Superficial Femoral Artery, To capitalize on this opportunity, Surmodics needs to position its Surveil DCB in limelight, ahead of the commercially available and the current market leader, Medtronic’s (MDT) IN.PACT Admiral DCB. To that effect, Surmodics has been enrolling patients in the head-to-head pivotal trial, TRANSCEND, which will compare Surveil DCB with IN.PACT Admiral DCB for treatment of peripheral artery disease in the upper leg. The enrollment is expected to be completed in the fourth quarter of fiscal 2019. Surmodics is also working to secure CE marking for Surveil DCB in 2019.

According to the company’s investor presentation, Surmodics also estimates a robust market opportunity in the below the knee (or BTK) disease segment, with 3.5 million patients expected to be affected with critical limb ischemia (or CLI) by 2020. Of these, 33% are estimated to witness amputation, while 20% will die within one year of treatment.

According to the company’s investor presentation, Surmodics has estimated the number of patients with end-stage renal disease (or ESRD) to be 5 million worldwide. While AV access is accounting for 1% of total procedures for these patients, it results in 7% of the Medicare costs associated with ESRD patients.

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To leverage this opportunity by reducing reintervention rates for BTK patients and improve costs for AV fistula patients, Surmodics had planned to initiate the first-in-human trial for at least one of its BTK or AV fistula access drug-coated balloons in fiscal 2019.

The company’s commercially available products are also witnessing robust demand

The recently launched Telemark .014 coronary and peripheral support microcatheter have been witnessing positive clinical feedback, thanks to excellent cross-ability of these micro-catheters for complex coronary and peripheral lesions. Combined with Surmodics’ Xtreme composite shaft technology, these microcatheters provide exceptional deliverability, kink resistance, and lesion crossing.

The recently approved .018 peripheral balloon catheter and .014 balloon catheter, both with a serene hydrophilic coating, have also been witnessing robust demand in fiscal 2018.

Finally, the company’s .014 PTA balloon catheter is also being evaluated by clinicians and other interested parties. The company expects to make this product remunerative in fiscal 2019.

Surmodic’s In Vitro Diagnostics’ business continues to be a leading player in the ELISA/EIA, immunoblot/western blot, line assay or microarray segments. To further strengthen its position in the diagnostic assay components business, the company has launched MatrixGuard Diluent to reduce the risk of false positives and ensure high stability.

Thrombectomy segment presents an exciting growth opportunity for Surmodics

The acquisitions of Creagh Medical and NorMedix added percutaneous transluminal angioplasty balloon catheter technology and minimally invasive catheter technologies, respectively, to Surmodics’ portfolio.

Surmodics acquired innovative thrombectomy platform technology and related intellectual property with broad potential peripheral vascular applications, such as in arterial thrombosis, pulmonary embolism, neuroendovascular embolism, and deep vein thrombosis, from Embolitech in May 2018. According to the company’s investor presentation, this acquisition has opened up a global thrombectomy market worth $400 million and growing annually at high single digits for Surmodics. The next-generation technology is expected to eliminate the need for the use of thrombolytics, which in turn is expected to reduce ICU time and bleeding complications, and improve patient outcomes.

Investors, however, cannot ignore certain company-specific risks

Surmodics is excessively dependent on a small number of customers, exposing the company to excessive business concentration risk. Revenue from Medtronic and Abbot accounted for 16% and 11% of Surmodic’s fiscal 2018 revenues, respectively. Three customers in the company’s In-Vitro Diagnostics business accounted for 17%, 10%, and 10%, respectively, of Surmodics’ IVD operating segment revenue. Loss of any of these customers can expose the company to a significant setback in revenues and cash flows. Additionally, Surmodics is also anticipating a decline in revenues resulting from the expiration of the patents governing its third generation hydrophilic coatings.

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In addition to risks facing its commercially available products, Surmodics expects to face stiff competition for its leading pipeline product, Surveil DCB, from Medtronic’s admiral IN.PACT platform. The company is also facing intense competitive pressures from other MedTech players for its IVD business.

A lot of the company’s future growth prospects depend heavily on the clinical and commercial success of Surveil DCB, which is still very much in mid-stage development. Any unfavorable news for the Surveil DCB product can have a significant impact on Surmodic’s share prices.

Despite the risks, Surmodics remains an attractive investment opportunity in fiscal 2019

At the end of September 2018, Surmodics had total cash of $65.02 million and zero debt on its balance sheet.

Wall Street analysts have projected the 12-month consensus target price for Surmodics to be close to $86.00, almost 81.97% higher than its current trading price. I believe that this estimate is more or less an accurate representation of the growth prospects of the stock.

Hence, I believe investors should consider adding Surmodics to their portfolios in fiscal 2018.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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