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Morningstar | Narrow-Moat ConvaTec Tripped Up by Poor Execution

Since its initial public offering two years ago, ConvaTec has followed a familiar playbook to press its advantage in advanced wound care and enhance its ostomy business. By and large, we like ConvaTec’s businesses that focus on chronic care, which translates into an ongoing stream of revenue. However, the company has lagged significantly behind its key competitor, Coloplast. From our perspective, there is plenty of opportunity for ConvaTec to remedy the situation, but its ability to execute hinges greatly on new management.We like the firm's strategy of innovation and patient retention, but for every step forward, ConvaTec has also seen setbacks in the form of packaging recalls, inventory shortages, and manufacturing glitches. The firm seems to be struggling with many process-related issues that leave too much room for operational errors. We like interim management's plan to address the problems, but hold tempered expectations on near-term improvements.In contrast to Coloplast’s dominant positions in ostomy and continence care, ConvaTec is strongest in advanced wound care and infusion sets for insulin pumps, thanks to investments and acquisitions by its private equity owners. As a result, ConvaTec has a formidable footprint in the wide-ranging market, including antimicrobial dressings and hydrofiber. We expect ConvaTec can extend the strength of its Aquacel brand to take more share in the $1.2 billion foam dressing segment. It enjoys market leadership in infusion sets, which we anticipate will continue, thanks to strong relationships with the pump makers.On the other hand, ConvaTec’s ostomy business suffered from benign neglect under the private owners. Although the ostomy market has grown 5% annually on average, ConvaTec’s ostomy division has posted declines in five of the past six years. We like the firm’s plans to roll out new products, enhance its relationships with ostomy nurses, and implement a more robust patient after-care program to improve loyalty. With only three major competitors carving up this global market, we think conditions are favorable for a turnaround. But, ConvaTec needs to execute well.