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Morningstar | Integra Reports 2018 Consistent With Expectations; 2019 Outlook Also Appears Achievable

Narrow-moat Integra reported 2018 results that were in line with our thinking and management's revised outlook following a particularly weak third-quarter report. We don’t see much in the release to suggest we need to tweak our long-term expectations, but we may raise our $58 per share fair value estimate by a modest amount to reflect the cash flows received since our last update. Overall, we think the stock sits near fair value following an approximate 7% rise in share price.

Management's commentary and outlook were solidly in line with the lowered expectations previewed on the firm's third-quarter release, which sparked a sizable sell-off in shares since the beginning of November. The year clocked in at 4.4% organic revenue growth, and 2019 is set to accelerate to a level nearer 5%, but we'd point out that this falls toward the low end of the company's long-run guidance of 5%-7%. Moreover, while management provided reasonable explanations for why overall performance should be weighted toward the second half of the year, we'd keep this in mind as investors assess future results in the coming months. For example, Integra will finally take full control of the global commercial operations for the recently acquired Codman franchise by the end of the third quarter, which should provide more financial visibility versus the unanticipated weakness that plagued the business in the second half of 2018. Additionally, improved sales force efficiency in the firm's restructured orthopedic territories and new product introductions should also contribute disproportionately later in the year. Separately, stabilizing the extremity orthopedic portfolio will be key to achieving the firm's long-run growth targets. While a small contributor to overall revenue, the product line's roughly 8% decline in the quarter created an approximate 50-basis-point drag to firmwide reported growth. We expect tuck-in acquisitions will be a focus for this area to bolster its competitive positioning.

Finally, reported performance is expected to fall slightly short of the 5% organic rate, due to roughly $10 million in headwinds from foreign exchange, and $5 million to $10 million in product discontinuations associated with the slated changes to medical device regulations in Europe. While there a lot of moving parts associated with Integra's financial performance over the coming year, we're encouraged by the consistent improvement in free cash flow conversion since the close of the Codman acquisition in 2017. Our model calls for this metric to reach 75% in 2019, and eclipse 90% in 2020, up from nearly 60% in 2018 and barely 46% in 2017.