Morningstar | Merit Continues to Post Superior Growth, but Stock Looks Too Expensive
Merit's first-quarter revenue grew modestly ahead of our full-year outlook, but the firm fell slightly short versus our expectations for gross margin expansion. We'll likely only make modest changes to our model, if any, but could see our $34 fair value estimate for this no-moat firm inch higher as we incorporate the cash flows received since our last update. For the quarter, reported revenue growth clocked in at 17.4%, compared with our full-year projection near 17%, with currency effects weighing on results to the tune of roughly 240 basis points. On an organic basis, the firm grew roughly 10% in constant currency, in line with our model and at the high end of management's guidance range of 8%-10% for the year.From a revenue perspective, the firm continues to perform well. The Cianna Medical transaction is living up to expectations and trending toward meeting management's initial outlook that called for $50 million to $56 million in revenue during 2019. In terms of profitability, gross margin fell short of our forecast for the full year on both a GAAP and non-GAAP basis. Merit reported 50 basis points of GAAP gross margin expansion year over year, compared with full-year guidance that implies approximately 130 basis points of improvement. On a non-GAAP basis, margins expanded 170 basis points versus nearly 200 expected for the year. However, the first quarter has typically been the weakest for firm profitability over the last few years, so we intend to wait for another quarter of data before adjusting our expectations.
While revenue growth at the firm has been exceptional over the last several years, free cash flow conversion has not. Free cash flow has lagged both GAAP and non-GAAP earnings for the better part of the last decade. We forecast GAAP earnings to more consistently approximate free cash flow over our forecast horizon but anticipate adjusted profits to continue exceeding actual cash generated, informing our dim view on valuation.
Merit Medical Systems manufactures and markets proprietary disposable medical devices used in interventional, diagnostic and therapeutic procedures, particularly in cardiology, radiology, oncology, critical care and endoscopy. The company conducts its business through two segments: Cardiovascular, which includes its Peripheral Intervention, Cardiac Intervention, Cardiovascular and Critical Care, Interventional Oncology and Spine and Breast Cancer Localization and Guidance product groups; and Endoscopy, which provides non-vascular stents to treat gastrointestinal and pulmonary disease including AERO?, AEROmini? and AERO DV? Fully Covered Tracheobronchial Stents and Alimaxx-B? Biliary Stent Systems.
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