While economic uncertainty continues to be high, I want to invest in companies that are looking to solve today’s biggest problems. This leads me to a fast-growing player in healthcare: Abiomed Inc (NASDAQ: ABMD). Even at 14x revenue and 56x forward earnings, Abiomed is priced at a reasonable level where the company is expected to produce both double-digit revenue growth and steady margins for the next 5+ years, leading the company to be undervalued today and a great investment opportunity tomorrow.
Source: Company Website
Why Abiomed Trades At 14x Revenue
Abiomed provides solutions enabling the heart to rest and recover by temporarily assisting the pumping function of the heart. Abiomed’s primary solution is the Impella Catheter, which is usually inserted to the left side of the heart and must be monitored through a special display designed by Abiomed called the Automated Impella Controller. The Impella is particularly effective in percutaneous coronary intervention (PCI) procedures, which are performed to relieve symptoms of coronary heart disease or reduce heart damage during or after a heart attack. Due to the continued aging of the population, the number of people with heart issues who may a PCI procedure continues to rise. There are already nearly 1 million PCI procedures in the US alone annually and this figure is expected to increase over the long term.
Abiomed has been a beneficiary of this trend, especially in higher-risk PCI procedures. Out of the near 1 million PCI procedures that happen in the US annually, about 300 thousand are considered to be higher risk. Of those, an Impella Catheter solution was just used 8% of the time. This leaves a lot of room for market penetration in the US alone. With that being said, growth in the US over the past year has slowed due to both the coronavirus and misleading research studies involving the Impella. Once the coronavirus cases start to flatten out in the US, I believe the usage of the Impella in PCI procedures will pick back up to its double-digit growth levels experienced in the past.
Even though the growth in the US slowed down, international growth continued to stay near 30% over the past year. Abiomed’s international growth stems from procedures in Germany and Japan, which combined expands the company’s annual addressable market by another 75 thousand procedures. In particular, growth in Japan will continue to happen and be the near-term driver of international sales. Abiomed’s long-term growth plan is to expand the use of the Impella in other European and Asian countries. The expanded list of countries will expand the current addressable market to over 4 million procedures, giving Abiomed plenty of runway to continue to grow.
Additionally, Abiomed’s latest acquisition of Breethe opens the door for even more patient utilization. Breethe has created technology that allows for extracorporeal membrane oxygenation (ECMO) therapy. This therapy is utilized primarily for patients with lung problems. Breethe’s system, called the OXY-1 System, is designed to remove carbon dioxide and add oxygen to a patient’s blood, much like a working human lung would. What also makes the OXY-1 different than other ECMO solutions is the potential portability of the machine, allowing for usage outside of the hospital.
With the ECMO capabilities, Abiomed has expanded its current addressable market in the US by another 25 thousand procedures. Abiomed is also working on a solution that combines Breethe’s technology with its Impella technology and is in the clinical study stage. If Abiomed can pull this off, the company can expand its current addressable market by another 200 thousand procedures in the US alone.
Abiomed has benefitted from the growth of the senior citizen population globally, leading to 24% annualized revenue growth over the past 3 years. Even with the coronavirus providing a possible short-term headwind, I expect the annual revenue growth to be in the 15-20% range for the foreseeable future.
On top of the long-term growth potential of the company, Abiomed has also done a good job managing the business with 24% net margins, 32% FCF margins, 20% ROIC, and no debt. So given the long-term growth tailwind and amazing profitability figures, you can see why investors would see 14x revenue for Abiomed as a bargain. But exactly how much of a bargain?
My Valuation Methodology
Intrinsic Value Assessment – Undervalued
Using Yahoo Finance’s average EPS estimate for next year and the long-run earnings growth, as well as the Yardeni Research’s market average PEG ratio, I utilized the PEG ratio to find the right P/E ratio to assess Abiomed’s valuation today given expected future growth. Over the past 5 years, the S&P 500’s average PEG Ratio has been 1.5x. Given Abiomed’s easy-to-understand growth trajectory, no debt, and great profitability metrics, I would be willing to pay a premium to buy Abiomed. At a 2.0x PEG Ratio, I estimate the value of Abiomed’s stock to be $304/share today. As of July 2, 2020, Abiomed’s stock price is $264, finding the stock to be undervalued by 13%.
Growth in Valuation Tomorrow
To get a sense of how a company will compound shareholder value over time, I look at the three sources of total returns for a stock: shareholder yield (share buybacks and dividends), profit growth, and changes in valuation multiple. I will estimate how they will change over the next 3-5 years.
Shareholder Yield – -1.0%
Abiomed’s shares outstanding have slightly increased over the past few years even though the company is FCF positive. I expect Abiomed to continue to increase share count in the future based on history. This means I expect EPS dilution from new shares being offered by the company. Abiomed also does not pay dividends.
Profit Growth – 16%
Given the current economic environment, I expect the revenue growth to be reduced closer to 10% over the next 1-2 years. Once the coronavirus pandemic passes, I expect revenue to increase back to ~30%, especially in the US. This, combined with neutral operating leverage, will lead to profit growth around 15%. This estimate is also lower than what Yahoo Finance expects from the company.
Change in Multiple – 100% of Today’s Multiple
Abiomed’s valuation multiples are still well below historical averages, leading me to not see that much downside from here. This means I will not have to decrease my expected growth in value over time.
By combining the expected shareholder yield and profit growth, then multiplying it by the expected valuation multiple degradation, I get the expected growth in valuation over time. For Abiomed, because I don’t expect any valuation multiple degradation, adding shareholder yield and profit growth together and will yield a 14% annualized expected growth in value over the next 3-5 years.
Putting It All Together
The combination of being undervalued today and growing its value at a double-digit rate tomorrow, I see Abiomed can double in value over the next 3-4 years, leading me to buy the stock.
What Can Go Wrong
The biggest threat to my thesis is Abiomed’s ability to increase sales in the US. I expect Abiomed has already started to turn the tide in the country and will be able to do so further once the coronavirus scare passes. If Abiomed cannot keep the revenue growth momentum going, then I would have to revise down my growth estimates. Another consideration is larger competitors. Although Abiomed is achieving fast growth and high ROIC today, this can change over time, especially in the US where Abiomed competes against many makers of heart devices, including the Heartwave solution from Medtronic (NYSE: MDT) and Edwards Lifesciences (NYSE: EW), which is another heart-based company that I’m bullish on. If competitors can limit the market share gains Abiomed is currently experiencing, then this could lead to slower revenue growth and even higher reinvestment due to more R&D spend to further enhance Abiomed’s solutions.
Based on my analysis, I will be buying Abiomed. At these current fundamentals, I would be willing to buy as long as the stock price stays below $300. I will be paying attention to the company’s patient utilization levels in the US and how it fluctuates quarterly, revenue mix between the US and international, and keeping tabs on the progress of the integration of the Breethe acquisition.
Disclosure: I am/we are long ABMD. 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.