Morningstar | Merit Medical Systems' 3Q Performance Exceeded Expectations; Raising Our FVE
No-moat Merit Medical reported third-quarter results that were slightly better than our expectations on both the top and bottom lines. As we update our model for the better performance, incorporate the Cianna Medical acquisition which is set to close by year-end, and account for the cash flows received since our last update, we intend to raise our fair value estimate to approximately $33 per share from $29. We continue to view shares as meaningfully overvalued.The firm reported sales growth of nearly 24% over the prior year quarter, or 15% on an organic constant currency basis. This compares with our forecast that called for a little over 20% reported growth, with an organic contribution closer to 11%. A primary driver of the difference came from the company benefiting from production issues at a competitor that management detailed on the second quarter call, which have lasted longer than originally anticipated. Management believes the firm benefited to the tune of approximately $4 million in the quarter, or roughly 225 basis-points, which helps bridge the gap between our estimates and reported results.
Importantly, firmwide gross margin has again begun to see meaningful expansion after a first half of the year that was flat versus the first half of 2017. In the quarter, gross margin expanded 170 basis points to 49.8% on a non-GAAP basis. In our view, this has been primarily mix-related as the company continues to bolt on higher-margin, higher-growth businesses. Best we can tell, core Merit continues to operate on a GAAP gross margin in the 40%-45% range. Operating costs came in slightly better than our forecasts, with lower research and development expense the biggest driver of better-than-expected operating profitability.
We think the firm is on track to meet management's maintained full-year guidance that implies roughly 20% revenue growth and over 200 basis points in gross margin expansion for the fourth quarter.
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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