With the macroeconomic recovery worldwide, birth rates have started to improve substantially and are gradually returning to historical levels. Hospitals are again making the nursery and the NICU (neonatal intensive care unit) their priorities. This will result in more capital spending in this area in near future. The trend has just begun, and has a long way to go before any significant reversal. One company that is set to gain from this new trend is Natus Medical (BABY), a global provider of newborn care products. Its shares rose as much as 40% after reporting its third-quarter earnings in October and I feel this is just the beginning.
In this investment thesis I will focus on BABY's opportunities in newborn care. The field in which Natus operates don't have lots of competition, which is the first advantage if you invest in this company. Moreover, this is a safe investment because the newborn care industry is recession-proof, which is the second advantage. At times of recession the business grows moderately and at times of boom the business grows by leaps and bounds.
The Business
Natus operates in a niche in the healthcare product industry. It is a global provider of newborn care products. In addition, Natus has the largest neuro-diagnostic sales and service organizations in the world. Its end-user customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies.
The company operates in one reportable segment in which the company provides healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, sleep disorders, and balance and mobility disorders. It generates its revenues either from sales of devices and systems, which are generally non-recurring, and from related supplies and services, which are generally recurring. The company was founded in 1987 and is headquartered in San Carlos, California.
In the third quarter of 2013, Natus has seen a rebound in its markets. The company's outstanding worldwide sales and service have allowed it to attain leadership position again in newborn care. The company has increased its focus on organic growth. The ability to leverage its product platforms and sales channels in the future will be meaningful. I am optimistic that the opportunities that lie ahead will drive significant revenue growth for Natus.
Opportunities
1. Amplitude-integrated EEG: The biggest opportunity for Natus lies in developing and selling advanced Amplitude-integrated EEG ("aEEG") monitors. The mortality from acute neurological disorders in the infancy, such as status epilepticus and stroke, is highest in newborns under one year of age. Certain forms of newborn brain injury, such as stroke, have an incidence as high as 1 in 4000 live births. Use of continuous Cerebral Function Monitoring ("CFM") through aEEG monitors in newborns provides quick vital information to clinicians in a non-invasive way to assist with earlier diagnosis and treatment. Amplitude-integrated EEG also has the potential to be used as a research tool for continuous brain monitoring in the NICU.
An aEEG is most commonly used as a clinical tool for screening of term infants before neonatal hypothermia therapy. It is also used it to follow brain function recovery after injury such as hypoxic ischemic encephalopathy. But opportunities for advanced aEEG application in preterm and mature infants are evolving rapidly. Such applications are increasingly being used as a reliable measure to establish the normative patterns of brain maturation from very preterm to term ages. Advanced aEEGs are also used in assessing the effects of medication on the cerebral background activity, prediction of neurologic outcomes after brain damage, and detection of seizures.
Natus provides Olympic CFM 6000 aEEG infant monitor for single-channel aEEG and Brainz BRM3 monitor for two-channel aEEG. The devices can simultaneously record raw EEG and display impedance values. Impedance measurement helps distinguish real brain signals from artifacts, which are spurious electrical signals generated from biologic and external sources. Natus also offers CFM Olympic Brainz Monitor, the latest technology in Cerebral Function Monitoring with tremendous growth potential in newborn care as well as a research tool. The device provides aEEG, real time EEG and continuous measurement of impedance in 1, 2, and up to 3 channel configurations. It is noteworthy here that Natus acquired privately-held Olympic Medical Corp. in 2006.
In a study examining the feasibility of aEEG in preterm infants in the NICU, Natus' Olympic CFM 6000 was proved to be an effective portable device. The device can be easily maneuvered around other equipments in the NICU, with a size and usability agreeable for nurses. The electrodes of CFM 6000 are identical, and its display unit is similar to a commonly accepted cardiorespiratory VDU.
Natus competes with a host of companies, such as EMS Biomedical, HEYER Medical, NeuroWave, Cardiplus, Danmeter ApS, Spacelabs Healthcare, Shanghai NCC Electronic, and SOMNOmedics in producing CFM monitors, all of which are privately held. This is the biggest advantage of the stock. If you would like to invest in this high growth industry, BABY is the only instrument available in the market.
Conventional EEG versus aEEG
To examine the efficacy of cost-effective aEEGs versus conventional EEGs, researchers from The Washington University conducted a study. In the study, both technologies were used simultaneously for an average of 18 hours per patient to monitor the brain activity of 21 newborns with seizures. Lead author Divyen Shah, M.D., a clinical fellow in the Division of Newborn Medicine, said:
We found that we could pick up seizure activity in most of the patients using aEEG monitors that included the raw signals. In most medical centers worldwide, conventional EEG isn't available because it's expensive and resource intensive. We've shown that when staff members have training in interpreting aEEG, it can be effective for monitoring electrical seizure activity in newborns.
2. Incubators and Warmers: Natus' second biggest opportunity lies in thermoregulatory management of neonates. Hypothermia is a frequent occurrence in newborns, and thermoregulatory management using incubators and radiant warmers is a fundamental part of medical stabilization. Since the first incubators were used, many advances in design have been made. Nursing in closed incubators was initially standard practice and provided reasonable control over the neonate's immediate environment. Subsequently, open care cots incorporating radiant warmers were introduced to provide easier access to the baby receiving intensive care.
Natus' closed incubator line offers controlled and consistent microenvironments for thermoregulation. Ranging from a value product to premium-level products for high acuity babies, Natus offers a choice of options to meet all patient-specific needs. Natus' lines of transport incubators are compact and lightweight, providing easy access and visibility during transport. In addition, the company provides infant warmers for optimal thermal support.
3. Neonatal Jaundice Management: Natus has its third biggest opportunity in neonatal jaundice management. Phototherapy, intravenous immune globulin ("IVIG"), and exchange transfusion are the most widely used therapeutic modalities in infants with neonatal jaundice. Natus is a global leader in phototherapy. It provides exceptional eye protection for neonatal phototherapy. Keeping eye shields in place over babies' eyes during phototherapy can be quite challenging. Natus' Biliband Eye Protector, with its unique design, provides a simple solution to this problem. The company's MediLED and MediLED Mini phototherapy lights provide high-intensity blue light for the treatment of newborn jaundice. In addition, Natus offers neoBLUE systems that incorporate optimal blue LED technology for the treatment of newborn jaundice. All neoBLUE systems deliver intensive phototherapy as defined by the American Academy of Pediatrics.
Natus directly competes with Phoenix Medical of India and Zhengzhou Dison Instruction and Meter Co. of China, two privately held companies, in providing infant thermoregulatory and jaundice management in Asia. There exist many such tiny companies all over the world, a majority of which are not listed in the stock markets. I believe a consolidation is inevitable in the newborn care industry. The industry is fragmented and I see tremendous growth for Natus, both organic and inorganic, in this industry.
Valuation
BABY's EPS has seen ~420% jump in the last one year. Revenue increased by ~15% during the same time.
BABY EPS Diluted (TTM) data by YCharts
The company's earnings are expected to increase at ~20% CAGR for the next three to five years. The company's consensus EPS for 2013 is $0.97. I expect that the turnaround in global macro-environment will boost BABY's 2014 EPS to around $1.20. The stock is currently available at 18.78x in terms of expected 2014 EPS. Natus has no direct competitors in the publicly listed space. Its indirect competitors include Johnson & Johnson (JNJ) and Astro-Med (ALOT). JNJ is trading at 16x one-year forward earnings and ALOT at 35x one-year forward earnings. Given the size and growth prospects of BABY, the stock appears cheap. Applying a P/E multiple of 25x on the expected 2014 EPS of $1.20, I get $30 as its one year projected price. But I believe that 25x is conservative, because I expect the company to deliver earnings surprises in the years to come. Actually this stock should be owned for the long haul.
Summary: Reasons to Buy
- Natus operates in a niche in the healthcare product industry, in which competition is less. The company is a global provider of newborn care products.
- With the macroeconomic recovery, birth rates have started to improve substantially and are gradually returning to historical levels. The hospitals are making the nursery and the NICU their priorities. Huge capital expenditure is expected in this area.
- Natus has huge opportunities in developing and selling advanced Amplitude-integrated EEG (aEEG) monitors. Aside from this, it has opportunities in neonatal thermoregulatory and jaundice management.
- The stock of the company is currently available at 18.78x in terms of expected 2014 EPS, which is quite cheap, given its growth prospects. I believe that $30 is very much possible from today's level around $22 within the next 12 months.
Risks
- Natus competes with bigger manufacturers such as Johnson & Johnson that make a wide variety of similar products. Natus also competes with smaller companies like Welch Allyn and Astro-Med in the industry. With macroeconomic recovery, all the companies will see higher demand for their products, and competition will increase. Hence, there is a chance that BABY's high growth rate will peter out with time. Moreover, hospital equipment industry grows out of necessity, not luxury. So there is a limit in its growth prospects.
- The bull thesis of BABY is primarily based on improved global macro outlook, which is still fragile in its initial phase. Any early reversal may hurt the bull thesis. However, the industry in which the company operates being recession-proof, this particular risk is not very high.
- BABY has cash and short-term investments that worth $44 million as of September 30, 2013. But its rising debt level is certainly worrying. However, its cash level increased by $15 million in the third quarter and it reduced bank debt by $2.5 million. The company said that its goal is to continue improvements in operating cash flow in the coming quarters and it expects to be able to pay off its long-term debt within the next year.
BABY Cash and ST Investments (Quarterly) data by YCharts
Conclusion
Natus has a lot of earnings momentum going with it right now, which is expected to be strengthened more going forward. I feel very encouraged with the direction Natus is going. Apart from earnings growth, the most important is its cash generation. For long-term investors, my advice is to buy the stock on dips.
Disclosure: I 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. (More...)
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