Back in August, we wrote a fundamental piece covering Globus Medical (GMED), following a sturdy Q2 exit and repeated pattern of growth for shareholders over previous periods. In that analysis, we observed strong return on capital employed of 7.3% alongside equally as impressive ROA and asset turnover of 52%, which signals performance for shareholders’ radar coming into the exit of Q3. However, what led us to holding an entry position was the valuation on trading of $54.99 at time of writing, where we deemed a fair value of only $26.88. Our DCF analysis observed a -51.12% value gap from intrinsic value to market price, which made for a hesitant entry decision where we were more happy waiting on the sidelines and advocating for entry on a 10-15% pullback on that price.
Well, we have arrived at that pullback right in the ranges to which we anticipated of $47.81-49.99, currently trading at $48.89 at the time of this writing, or a 12.4% pullback from the previous analysis. Our strategy is now simple – we now advocate for immediate entry at current trading, which increases the upside on forward momentum and gives greater reallocation scale back up to $54-55 and beyond, which we are extremely confident the company will achieve over the next 1-3 year period. This forecast is based on company growth catalysts and market expectations, namely the reopening of medical procedures and greater uptake in surgery utilisation coming into the end of 2020 and into 2021, now that things will settle from the pandemic-induced chaos.
Throughout the pandemic, to manage risk, we have been in favour of smaller allocations in long positions, in the ranges of 0.1-0.5% of NAV, where we see strong fundamental and price momentum moving into the medium term. Keeping the smaller position size allows for two main benefits; a more swift exit in the case where the stock moves a further 10% south, plus gives some wiggle room to refine the hypothesis over the coming weeks to months as well. In addition to these pointers, we have advocated an options hedging strategy by purchasing December expiry out-of-the-money put options, at the strike of $85 on current implied volatility of ~85%, now with 74 days until expiration. We anticipate the price momentum back up to $54-55 and beyond to cover the contract cost relative to our position size.
Data Source: Trading View GMED
To further manage risks associated with recent market turbulence, we advocate to opt for a shorter- to medium-term holding period as opposed to long-term allocation. Although we are in favour of longer-term positions, we are of the current belief that one can benefit from taking profits earlier than originally anticipated, for protection against the downside in price movements over this period and to maximise the benefit from the upside.
We firmly believe the fundamental case for GMED has been made and reiterate our bullish outlook on the company, equally as firm on the belief that we would own the whole company given the chance. This is especially true considering growth catalysts and GMED’s economic moat in comparative advantages within the neuromusculoskeletal interventions playing field. What is most impressive within GMED’s product suite is the superior nature that is offered within the spinal reconstructive surgery domain to candidates for these types of procedures.
On current figures, and adjusting for recent figures and applying the discount rate we are accustomed to, we see a correction in valuation that resembles a small value gap to the downside, albeit more in line with our expectations of a value play. Investors may observe a snapshot of our DCF valuation below, where we have assigned a terminal growth rate from the PRAT model of DuPont and the discount rate reflective of the opportunity cost over investing in the market index alongside the risk-less treasury yield.
Data Source: Author’s Calculations
The blue-sky case is further bolstered by the fact investors have been constantly rewarded for the level of downside risk at play, particularly in recent times. We anticipate further reward in the event of a turnaround in price with a run-up back towards the $50 and above range, thus also highlighting the case for entry at the current trading price and valuation. With a P/E of ~54x, PEG of 3.91 and forward P/E of 26.78x, the market certainly has high expectations for performance in the stock, and our thesis is further enhanced by the data available evidencing high-growth companies within the S&P 500 this year have experienced +30% growth on average whilst holding P/E and high PEG labels throughout the period YTD.
Data Source: Author’s Calculations from previous analysis
We look forward to completing a far more thorough GMED analysis during earnings season after Q3 filings, where we anticipate to complete a comprehensive forecast of revenues, earnings, and valuation estimates over the coming 5-10 years. Until then, we are happy with our long position into the stock, citing the correction in valuation and pullback to more respectable levels in price for our reasoning, as mentioned previously throughout this article.
GMED is in the position to benefit from comparative advantages within the spinal reconstructive surgery domain. This is especially true with increased uptake in spinal reconstructive surgery utilisation with the gradual reopening of medical facilities in the USA and abroad.
Uptake in advancements within this domain of surgery have remained stagnant, as more traditional interventions, such as pedicle screw and rod procedures, spinal fusions and intervertebral disc interventions involving spacers and corpectomies, remain among the gold standard for spinal pathology requiring reconstructive attention.
GMED remains at the head of the bull producing implants for these surgeries, thus positioning the company in a pioneering front to build on these technologies in producing interbody fusions of the vertebral body, alongside dynamic stabilisation procedures alongside biological products such as osseous allografts and synthetic versions of the same standard. Where the benefit lies within this suite is in the adaptability to the naturally occurring anatomical variants that exist between humans, thus improving patient outcomes.
We are extremely satisfied with this correction in price respective to valuation and look forward to our investment hypothesis panning out over the next 12 months. What will be under the most intense scrutiny in this thesis is the movement of the stock price back up to $54-55, where we can allocate additional capital up until this point. Considering the fundamental factors under consideration for GMED, the market seems to hold high expectations for the company, which will see investors benefit from the upside, with historically high Sortino ratios demonstrating that shareholders have consistently been rewarded for the level of downside risk at play. We look forward to continuing to follow the GMED story and providing regular updates on our position and thesis surrounding coverage of this company.
Disclosure: I am/we are long GMED. 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.