The healthcare industry has yielded large gains for investors over the last two decades as new treatments and medical devices have come to market. While large companies dominate this space, there are also some hidden gems to be found among small-cap healthcare companies.
One such stock is OrthoPediatrics (NASDAQ:KIDS), a smaller company engaged in the medical device business.
OrthoPediatrics is a medical device company specializing in orthopedic implants for children. The company makes implants for use in trauma, deformity and reconstructive cases.
Unlike other medical device manufacturers that also serve this market, OrthoPediatrics focuses its efforts exclusively on providing devices for children.
OrthoPediatrics Revenues and Margins
In Q4, OrthoPediatrics generated $24.8 million in revenue, bringing the full-year total to $98 million.
Gross margin for the quarter was 72.9 percent, while full-year gross margin was 74.9 percent. Both of these margin numbers represented slight decreases compared to the previous periods at 79.9 percent and 77.4 percent, respectively.
OrthoPediatrics Growth
The Q4 results demonstrated that OrthoPediatrics is on a strong growth trajectory. Revenue for the quarter was up 31 percent, while revenue for the year rose by 38 percent.
Growth in international sales was particularly impressive, with a year-over-year increase of 363 percent in Q4. Further growth is expected in 2022, with the company projecting between $118 and $121 million in revenues for the year.
Although the company still lost money in 2021, there was substantial improvement in its bottom line. For the full year, OrthoPediatrics lost just $0.2 million, compared with $5.9 million in 2020. Adjusted EBITDA is expected to turn positive in 2022.
While this growth is certainly impressive, it’s important to note the still relatively small totals involved.
OrthoPediatrics is a company that is still in its early stages, having been founded in 2006. Clearly, the company still has ample room to grow, especially where international sales are concerned.
Competition: It is relatively unique in its narrowly focused approach to orthopedic implants for pediatric patients. That isn’t to say, however, that the company lacks competition in this market. Other key companies that are in competition with OrthoPediatrics include Johnson and Johnson (JNJ), the Stryker Corporation (SYK) and Pega Medical.
Market Size: OrthoPediatrics operates in a medium-growth segment of the biomedical industry. In 2019, the market for pediatric orthopedic implants was $1.6 billion. That market is projected to grow at a CAGR of 10.2 percent through 2027, reaching $3.5 billion.
Valuation
Based on various valuation metrics, OrthoPediatrics is overvalued. Several of the company’s key price metrics are above the industry average, raising potential concerns for value investors.
Price-to-book, for example, sits at 4.58 for OrthoPediatrics, compared to an industry average of 2.78. Price-to-sales is similarly high at 10.57 against an average of 5.43.
With that said, it’s critical to remember that OrthoPediatrics is a young company on the verge of profitability. As such, higher-than-average valuation metrics aren’t terribly unusual. If the company can sustain its growth trajectory, these modest valuation issues will likely begin to resolve over the next few years.
Our valuation analysis shows that fair market value sits at $35.40 per share. Investors who are interested in jumping on board should wait for a pullback if a margin of safety is desired.
Competition & Margins Pose Threats
The risk factors for OrthoPediatrics mostly stem from its competition. As noted above, such large entities as Johnson and Johnson and the Stryker Corporation are also active in the market for pediatric orthopedics.
Although this market is growing, the projected CAGR of 10.2 percent isn’t terribly high. As a result, the companies doing business in this space will have to compete with each other to grab off new market share as it is created. OrthoPediatrics’ growth is quite promising, but much larger corporations could still retain the upper hand in this area.
Declining margins could also be a modest concern. It’s worth noting that the company’s gross margins are still excellent, exceeding 70 percent in 2021. If the trend of shrinking margins continues, however, it could begin to present issues for the company at some point down the line.
There’s also some slight risk associated with buying a company that is still sustaining losses. Given the very small full-year loss from 2021 and the fact that the company expects to have a positive EBITDA in 2022, though, this point is very nearly moot.
The larger question is how long after that point it will take OrthoPediatrics to produce significant profits. Based on its growth rate, though, long-term investors likely don’t have too much to worry about in this area.
Is OrthoPediatrics a Buy?
Overall, there’s a great deal to like about OrthoPediatrics stock. The company’s growth, high margins and rapidly approaching move into profitability all suggest that the company could be a good buy.
Growth in international markets is also extremely favorable for OrthoPediatrics. While larger competitors like Johnson and Johnson could squeeze the company for market share in North America, their edge may be somewhat less significant in foreign markets.
Though there are risks associated with the stock, they appear to be outweighed by the benefits. A high price relative to current sales and book value is a legitimate concern. However, it’s also quite normal for a company in OrthoPediatrics’ position.
Likewise, the company’s lack of profitability will almost certainly resolve itself this year. The biggest risk is that OrthoPediatrics will fail to gain market share against larger competitors. International sales and a tight focus on the pediatric market, however, should serve to blunt even this concern.
Perhaps the most promising confirmation of this view comes in the form of analyst price targets. The median target price for OrthoPediatrics over the next 12 months is $70, a gain of 40.2 percent over the current price of $49.94. Even more compelling is the fact that the lowest target price is $65, a gain of 30.2 percent.
With these targets, OrthoPediatrics could offer large returns even by substantially underperforming analyst expectations. As such, the next year looks extremely favorable for the stock.
The real potential of OrthoPediatrics, though, is over the long haul. Though the stock could see high returns this year, buying now and holding while the company grows along with its chosen market is likely the best approach.
Over the next 10 years, OrthoPediatrics will continue to expand, achieve profitability and continue to develop new devices to gain new customer bases. The result of this should be sustained share price growth that will favor early investors with excellent cumulative returns.
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