Since my earlier article on STAAR Surgical (NASDAQ:STAA) revealed on 28 November 2022, the inventory value has risen 34.6% from $58.93 to a excessive of $79.34 on 2 Feb 2023 however not earlier than it first cratered 20% to $46.82 on 28 December 2022. And from that February excessive of $79.34 it crashed once more, this time by 30% to $55.39 on 28 February 2023.
Two causes led me to put money into STAA within the first place – the standard of the management and the basics of the corporate. In my earlier article, I centered on CEO Caren Mason who led the transformational change at STAA that improved the enterprise fundamentals and introduced it to new heights. Then, there was a CEO change in December 2022.
I do know little concerning the new CEO Mr. Thomas Frinzi, aside from he was appointed to STAAR’s Board of Administrators in June 2020 and had expertise within the ophthalmic and medical machine industries at each giant, well-established firms and revolutionary start-ups. Previous to becoming a member of STAA, he served as Worldwide President, Surgical for Johnson & Johnson’s (JNJ) Imaginative and prescient enterprise, and beforehand served as Senior Vice President of Abbott Laboratories (ABT) and President, Abbott Medical Optics (AMO). And earlier than Abbott, Mr. Frinzi served as President and CEO of WaveTec Imaginative and prescient, a developer of surgical techniques for eye surgical procedure. Moreover, he beforehand held senior positions in industrial operations, enterprise growth, and gross sales and advertising and marketing at Bausch & Lomb Surgical, Refractec and Chiron Imaginative and prescient.
Primarily based on all this stuff, one can say that the present CEO Thomas Frinzi has related business expertise, has served in a CEO capability earlier than (albeit a a lot smaller firm that was later acquired), and he has expertise with STAA since he served on the board since 2020, so he appears to be a great match for the function. Nevertheless, solely time will inform if he can do effectively at STAA as a result of Caren Mason left massive sneakers to fill.
Caren Mason did her job of turning the corporate round and setting it on stable footing. The present CEO simply has to regular the rudder for the enterprise to proceed to do effectively, barring any unexpected adjustments.
With that mentioned, my focus on this article will likely be on the enterprise fundamentals and the course the present CEO is taking the corporate.
A Recap of the STAAR Surgical Enterprise
Go for a enterprise that any fool can run – as a result of eventually, any fool most likely goes to run it.
Peter Lynch famously mentioned that in an interview with the newspaper USA Immediately in 1989. I’m quoting one of many best funding legends of our occasions to not disparage the present CEO however to emphasize that an distinctive enterprise can proceed to do effectively within the absence of an distinctive chief at its helm if the enterprise mannequin is easy, can just about run on autopilot, the product is forward of its friends, and the corporate has a dominant market share. All a CEO must do is observe the established playbook and the enterprise ought to be wonderful.
So, is STAAR Surgical such a enterprise?
I coated the enterprise in-depth in my earlier article, so here’s a temporary recap.
What Does STAA Promote?
Based on its most up-to-date 10K,
STAAR Surgical Firm designs, develops, manufactures, and sells implantable lenses for the attention and supply techniques used to ship the lenses into the attention. We’re the main producer of lenses used worldwide in corrective or “refractive” surgical procedure. We now have been devoted solely to ophthalmic surgical procedure for over 40 years. Our aim is to place our refractive lenses all through the world as main and premium options for sufferers in search of visible freedom from carrying eyeglasses or contact lenses whereas reaching glorious visible acuity by means of refractive imaginative and prescient correction. We additionally make lenses to be used in surgical procedure that treats cataracts.
The 2 key STAA merchandise are the implantable Collamer lens (ICLs) and the intraocular lens (IOLs). As talked about in my earlier article, STAA has been progressively transferring away from the much less worthwhile IOL phase to concentrate on the extra worthwhile ICLs phase. On the This autumn 2022 earnings name, CFO Patrick Williams reiterated the corporate’s course introduced within the earlier earnings name to cease supporting the lower-margin cataract IOL enterprise by the tip of 2023, to concentrate on the extra worthwhile ICL phase.
What Is STAA’s Enterprise Mannequin?
I’ll describe the enterprise mannequin as easy. In spite of everything, 100% of the Firm’s gross sales are generated from only one phase, the ophthalmic surgical product phase. There are 4 elements to STAA’s enterprise mannequin.
Firstly, STAA develops a superior product and regularly invests in analysis and growth to enhance the product.
In 2023, STAA intends to focus its analysis and growth efforts within the following areas:
- Improvement of presbyopia-correcting ophthalmic medical gadgets, together with fashions that right cylinder (i.e., astigmatism), together with scientific trials of the identical;
- Improvement of preloaded injector techniques for ophthalmic medical gadgets; and
- Improvement of a brand new era of ophthalmic medical gadgets and supplies.
Analysis and growth are usually not only for creating revolutionary merchandise. The physique of data on STAAR Surgical’s Implantable Collamer Lens (ICLs) merchandise is intensive. A search on Google Scholar utilizing the key phrases “STAAR Surgical implantable collamer lens” yielded 1450 outcomes. This yr alone, 23 analysis papers have already been revealed on STAA’s ICL. All this physique of analysis, lots of that are on establishing the reliability and security of STAAR’s merchandise, will definitely go a protracted option to persuade surgeon shoppers to undertake its ICL and persuade completely different regulatory authorities around the globe that its merchandise meet the security necessities for a medical machine registration license which is able to enable STAA to proceed to promote within the presently greater than 75 international locations worldwide, and open doorways to STAA promoting its merchandise to extra international locations and therefore growing its whole addressable market.
Future Market Insights initiatives that the worldwide implantable collamer lens market will develop at a 13.1% CAGR to achieve a market dimension of $838.2 million by 2023. Based on STAA’s June 2022 Investor Presentation, STAA had already established a large foothold of round 9% of the world’s ICL market share.
Primarily based on this examine, there ought to be round 2.6 billion folks globally (34% of the world’s inhabitants) with myopia. That quantity is anticipate to extend to three,361 million by 2030 (39.9% of the worldwide inhabitants). These research underline the massive tailwinds behind industries that tackle this rising downside.
Due to this fact, I’m glad to listen to administration reiterating their spending on R&D. For fiscal 2023, STAA expects R&D expense to be roughly 13% for the total yr which is roughly $11 million every quarter of $44 million, up from the $36 million in 2022. Nevertheless, regardless of the rise in R&D spending, this represents a lower in spending as a share of anticipated 2023 gross sales. Extra on this later.
Secondly, STAA educates eyecare physicians and surgeons relating to the efficacy of their merchandise. STAA will then practice surgeons and certify them to implant EVO lenses. In the USA, STAA exceeded its aim of coaching 600 surgeons by the tip of 2022. The USA is a fast-growing marketplace for STAA because it acquired FDA’s approval of its EVO ICL product in March 2022. Having that first-mover benefit is an enormous deal. ICL unit development within the U.S. exceeded the earlier outlook and was up 55% year-over-year in fiscal 2022 and up 109% year-over-year within the fourth quarter.
Though the U.S. market isn’t the biggest piece of the pie, it is among the quickest rising geographically.
Whereas gross sales in its largest market, China, jumped by 100% from 2020 to 2022, gross sales in North America surpassed that, growing by 138% in the identical interval.
This autumn 2022 earnings name commentary from the CEO is bullish on the U.S. entrance:
Physician Finder visits within the U.S. had been up roughly 600% year-over-year within the fourth quarter…
My conferences in current weeks with surgeon clients affirm the expansion alternative for EVO within the U.S. In a single assembly, I met with a person surgeon, growing his dedication to EVO from 100 lenses per yr to 500 plus. In one other occasion, I met with a laser imaginative and prescient correction chain that’s growing its dedication to EVO from 500 lenses to 2,000-plus annual lenses in 2023.
Thirdly, STAA spends a major quantity on gross sales and advertising and marketing which search to place the ICL as a premium and first choice for applicable sufferers on the clinic and by way of digital and social media.
The advertising and marketing efforts contain its personnel attending and taking part in main ophthalmic conventions around the globe, investing in market growth, working towards help, healthcare skilled coaching, and affected person outreach. STAA has began working extra carefully with main refractive clinics within the space of coaching, product consciousness, and follow growth.
STAA goes past coaching and certification to allow surgeons to really feel assured with EVO. STAA’s focus for 2023 will likely be to extend surgeon consolation, confidence, and dedication to EVO ICL by surrounding these surgeon clients with gross sales, scientific, and advertising and marketing help as they work so as to add EVO ICL to their practices and/or remodel their practices for extra lens-based refractive requirements.
All these meant that the corporate expects promoting and advertising and marketing bills will likely be roughly 38% of internet gross sales. Whereas I’m glad the corporate is sustaining the spending on this class to help surgeons and to extend consciousness of its merchandise, 38% of internet gross sales are considerably decrease than what STAA spent in any of the years prior. Extra on this later.
Fourthly, STAA continues to increase internationally, and particularly in its largest market – China. Gross sales to China have doubled from $71 million in 2020 to $148 million in 2022.
With China enjoyable its zero-Covid measures, the CFO expressed cautious confidence that gross sales in its largest market will additional normalize as the height summer time implant season for ICL procedures closes in and STAA can meet its whole gross sales outlook for the total yr of fiscal 2023 of roughly $340 million, representing a 26% development over fiscal 2022 ICL gross sales of roughly $270 million.
To conclude this phase, I’ve damaged down STAA’s enterprise mannequin into these 4 elements. To be clear, it was Caren Mason who labored out the nuances of the STAA playbook and turned the corporate into the profitable enterprise that we all know right now. These easy steps – proceed to put money into R&D, develop the fast-growing home enterprise, put money into gross sales and advertising and marketing to coach eyecare surgeons and help them clinically and in their very own advertising and marketing, and increase internationally – are just about one thing anybody can observe.
Later, we are going to see if the present CEO is following the playbook or if he’s altering it.
The Present Fundamentals
This firm is an incredible turnaround story, dramatically turning 4 consecutive years of unfavourable revenue to sustained and rising optimistic revenue since 2018.
Between 2018 and 2022, income elevated by 129%, and internet revenue surged by 680%, and all this occurred despite the pandemic and the accompanying strict measures in hospitals that delayed non-essential procedures.
In the identical time interval between 2018 and 2022, STAA doubled its money and money equal place from $104 million to $212 million. And after accounting for all its debt, STAA is in an envious internet money place of $181 million.
To not belabor the purpose concerning the power of the steadiness sheet however there are usually not many firms that I do know of which have a unfavourable internet debt steadiness sheet. Corporations with unfavourable internet debt possess extra cash and money equivalents than their monetary obligations, and therefore are extra financially secure. Only for the sake of comparability, let us take a look at the web debt state of affairs of a number of the largest U.S. firms in Fortune 500.
This isn’t to say firms like Walmart (WMT) and Amazon (AMZN) are going out of enterprise. If firms have sturdy operational money flows, and the compensation interval for the long-term debt portion is staggered a few years out, having some debt isn’t a difficulty; some debt may even be a great factor when effectively managed. Nevertheless, when investing in a a lot smaller firm like STAA that’s working in very unsure macroeconomic occasions, it’s comforting to know that this firm has extra cash than all its debt mixed.
Throughout the Q3 2022 earnings name, then-CEO Caren Mason mentioned:
As we glance to fiscal 2023, regardless of the aforementioned challenges, we anticipate to attain roughly 30% ICL gross sales development year-over-year to roughly $355 million in whole firm internet gross sales, which contemplates restricted gross sales from different merchandise.
When the corporate reaffirmed steering for FY 2023 with a decrease $340 million in internet gross sales than beforehand guided, and was additionally decrease in comparison with the roughly $344.0 million from analysts’ consensus, the share value dropped sharply.
From 2018 to 2022, buyers have been used to STAA rising income at a quick clip starting from 21% to 41%, excluding 2020. And primarily based on administration’s income steering for 2023, it’s guiding for a 19.6% income development fee which by itself is nice however taken into the context of STAA’s previous historical past, 19.6% is disappointing.
And as if on clockwork, analysts adopted by decreasing their value targets and a few like BTIG Analysis even moved STAA from a Purchase score to a Maintain.
Ryan Zimmerman from BTIG Analysis, the identical analyst who upgraded STAA from Impartial to Purchase with a value goal of $98 a yr in the past primarily based on the FDA’s approval of EVO ICL enabling extra U.S. physicians to contemplate attempting EVO ICL despite the fact that China’s zero-Covid coverage delayed refractive surgical procedures in varied supplier places, simply lowered his name from Purchase to Maintain at a time when precise development in U.S. gross sales had proven to be sturdy, and China has lifted its zero-Covid coverage. He questioned if the corporate can improve its market penetration in China to satisfy its fiscal 2023 steering. In his be aware to buyers, he wrote that STAA is “wed to China and buyers are subsequently wed to the undulations of the Chinese language financial system.” To attain STAAR’s fiscal 2023 income steering of $340 million, STAA has to “improve market penetration by lots of, if not a thousand, foundation factors to satisfy its outlook” and he believes these will increase are more likely to show difficult.
I get his concern concerning the focus danger however simply as I don’t observe his reasoning for the optimistic value goal in 2022, I don’t observe his pessimistic view for 2023.
If STAA’s income development in a rustic with 2 billion folks will likely be a difficulty in 2023, how would the explosive improve in gross sales in China be defined if there isn’t any demand?
And is it actually so dangerous for STAA’s development to be “wed to China and buyers are subsequently wed to the undulations of the Chinese language financial system”, when China’s GDP development is anticipated to be the very best for the subsequent three years when in comparison with the USA in addition to the remainder of the G-20 international locations?
The identical analyst, together with a colleague, wrote one other be aware in December 2022. In it, they mentioned they priced in 25% development for STAA, but when the corporate grows under that stage, share costs might fall into the $30 vary.
But, regardless of the dearth of enthusiasm from analysts basically, as of three March 2023, the consensus value goal on STAA continues to be $79.50, representing a 32% upside from the closing value of $59.94 on 3 March 2023.
Valuation Primarily based on Future Progress Expectations of Earnings and Gross sales
From the perspective of P/E, P/S and P/B, STAA is loopy costly. But, when evaluating these identical valuation metrics to STAA’s 5-year common, one has to agree it’s positively cheaper.
Valuation Utilizing Peter Lynch’s PE = Progress Price
In his e book One Up on Wall Avenue, Peter Lynch defined one in every of his most well-liked metrics for figuring out a high-level valuation of a agency’s funding prospect. Given a inventory’s price-to-earnings (P/E) ratio and development fee, he interprets them as follows:
The P/E ratio of any firm that is pretty priced will equal its development fee. . . . If the P/E of Coca-Cola is 15, you’d anticipate the corporate to be rising at about 15 p.c a yr, and so forth.
Taking the very best vary of analysts’ forecast of the earnings development fee of 37.5% for the subsequent 3 years (and therefore a PE of 37.5), and assuming the diluted earnings for STAA get well to $1.66 per share by FY 2025, valuing STAA this fashion will end in a good worth of $1.66 x 37.5 = $62.25 which signifies that STAA is buying and selling round truthful worth now if it might maintain a development fee of 37.5% for 3 years.
If the expansion fee falls to 30%, nonetheless, then the truthful worth declines to $1.66 x 30 = $49.80.
Valuation Primarily based on Earnings Progress and Earnings A number of
In my earlier article, I wrote:
As long as the development charges are capable of maintain at 30% or increased, the draw back is restricted whereas the upside is 2 to six occasions greater than the draw back
Properly, analysts are actually projecting a decline in earnings per share in FY 2023. STAA generated $0.78 in diluted earnings in FY 2022. FactSet analysts anticipate that to say no to $0.61 in FY 2023 earlier than doubling to $1.20 in 2024 and rising to $1.66 in FY 2025.
In different phrases, regardless of the anticipated fall in diluted earnings in FY 2023, FactSet analysts nonetheless anticipate a mean diluted earnings per share development fee of 37.6% for the subsequent three years.
Refinitiv analysts are forecasting decrease diluted earnings per share development fee of 30% per yr for the subsequent 5 years.
SPGI analysts are additionally forecasting a 30% development in earnings per share for the subsequent 3-5 years.
Averaging these provides me consensus analysts’ expectation of 32.5% development fee in diluted earnings for the subsequent 3-5 years. For a long-term funding, a 32.5% earnings development fee is engaging, and my earlier funding thesis continues to be largely intact.
Nevertheless, I have to take care of the truth that the reiterated steering of $340 million is $15 million shy of the earlier steering of $355 million, suggesting that the administration is setting a decrease bar in anticipation of probably extra headwinds. Additionally, the state of affairs now could be much less rosy than the state of affairs depicted primarily based on Q3 2022 steering and analysts’ forecasts then. Because of the lowered earnings development forecast, I do agree with analysts’ lowered consensus value goal of $79.50 representing much less upside than once I wrote my earlier article.
The desk under lays out potentialities.
I assumed a 20% fall in diluted earnings in FY 2023, adopted by various EPS development charges from 20% to 40% in 5 eventualities in 2024. The row highlighted in yellow is the most probably state of affairs with EPS development fee of 30% (closest to analysts’ newest projections).
To construct in a margin of security in my assumptions, I thought of three doable valuations that STAA can commerce at, every at various ranges of low cost to the present PE of 76.85 to simulate additional de-risking. Keep in mind that the bottom STAA has ever traded at was a PE of round 61 on 30 December 2022, and my best-case state of affairs assumes its PE corrects to that lowest stage.
Within the best-case state of affairs the place PE falls an extra 20% to a PE of 61.48, investing in STAA on the present value of $59.94 supplies a doable 16% upside if earnings can develop at a mean of 30% per yr for 2 years. Within the worst-case state of affairs the place PE falls by 40% to 46.11, investing in STAA now might end in a 13.5% loss. Primarily based on an earnings development fee of 30%, and a balanced risk-reward investing utilizing my conservative assumptions on the present value, I’ll say that STAA is pretty valued now.
A great (or poor) funding is all the time a operate of value. Howard Marks as soon as mentioned:
It is not what you purchase, it is what you pay for it that determines whether or not one thing is an effective funding.
Shopping for STAA on the value of $55 at which it traded for 3 days from 28 February 2023 to 2 March 2023 would have supplied a 25% upside in two years with only a 7% draw back. At that value, STAA would have been undervalued and a very good purchase.
3 Dangers Related With This One-Trick Pony
The primary danger is a perceived divergence from Caren Mason’s STAA playbook.
A part of Caren Mason’s STAA playbook is to take a position closely in SG&A and in R&D. I intentionally remoted the R&D portion out from SG&A to mirror the 2 completely different functions of the bills: one is on gross sales and after-sales help, and the opposite is on product growth.
Spending on SG&A is a vital evil for a lot of companies. Suppose KO and PEP. Coca-Cola (KO) spent 30% of its gross sales on SG&A in 2022, barely decrease however not too removed from the proportion it spent in 2013 (36.9% of gross sales) and in 2003 (35.6% of gross sales). PepsiCo (PEP) spent 38.8% of its gross sales on SG&A (excluding R&D) in 2022, near 37% of its gross sales in 2013 and much increased than the 25.6% of gross sales in 2003.
The identical goes for STAA. Actually, it’s much more vital because the gross sales transcend merely convincing surgeons and sufferers to make use of EVO ICL. To make sure there’s continuous gross sales, STAA must help eye surgeons with coaching, certification, and help clinically and in advertising and marketing.
This is the reason I’m involved when the introduced spending on SG&A (excluding R&D) is considerably down, from its previous 8-year common of 52.5% to the projected 37.9% in 2023. Has STAA reached a dimension such that it might now spend incrementally extra in precise quantum however far much less as a share in income? Or is the brand new CEO trying to chop again on prices to extend the web revenue attained in 2023 to spice up these earnings per share?
Likewise for R&D spending. As a share of 2023 gross sales, the corporate is anticipated to spend simply round 13%, a 28.6% discount from its 8-year common R&D spend of 18.2% of gross sales throughout Caren Mason’s time in STAA, edging nearer to the 11.7% of gross sales spent within the horrible period earlier than she took over the reins.
I have no idea the intent of the CEO however makes an attempt that may be interpreted as inflating internet revenue artificially by means of drastic cost-cutting often concern me tremendously. That is authorized, positively, and lots of firms do this, particularly in current months with firms asserting layouts and cutbacks in spending to spice up profitability. Nevertheless, it doesn’t imply I’ve to love it, particularly when these strikes probably diverge from the profitable playbook employed by the earlier CEO.
The second danger is China.
My former boss beloved to say,
Your power can be your weak point.
China is STAA’s largest market, representing greater than 50% of its whole income, a rise from 43.9% of its whole gross sales in 2020 to 52.1% in 2022. The expansion of EVO ICL in China is actually spectacular however this single-market focus is certainly a danger that buyers need to issue into their funding resolution and asset allocation. If commerce relations with the U.S. had been to bitter and end in commerce restrictions, if social or political unrest had been to disrupt enterprise in China, or if different occasions in China considerably decreased or disrupted enterprise actions in China, that will materially and adversely hurt STAA’s enterprise. Though I like STAA’s dominant market-leading place, I can’t go all-in with this firm.
The third danger is competitors from LASIK.
EVO ICL procedures stay at a premium to LASIK. Completely different clinics will provide barely completely different costs, however simply to have a way of the numbers, this explicit clinic expenses $3,998 – $5,498 for a LASIK therapy for each eyes, whereas the associated fee for EVO Visian ICL procedures ranges from $7,998 – $8,998 for each eyes.
This clinic gives an awesome comparability desk itemizing the professionals and cons of assorted options to ICL. There are clearly many extra benefits to utilizing ICL versus LASIK. One among these is sufferers handled with LASIK have increased dangers of dry eyes and cornea flap an infection, whereas sufferers handled with ICL don’t encounter any of those points. The Federal and Drug Administration is presently weighing whether or not or not surgeons ought to present extra warnings concerning the dangers associated to LASIK surgical procedures. In a draft steering from July 2022, the company prompt that sufferers ought to be explicitly knowledgeable concerning the dangers of dry eye, issues driving at evening, visible disturbances – or different uncommon however extra severe unwanted effects associated to the surgical procedure. If FDA does cross such steering, it might probably push extra shoppers in STAA’s means.
Warren Buffett was as soon as requested what attracted him to the administration of Moody’s (MCO), to which Buffett responded:
I knew nothing concerning the administration of Moody’s. I’ve additionally mentioned many occasions in studies and elsewhere that when a administration with popularity for brilliance will get connected with a enterprise with a popularity for dangerous economics, it is the popularity of the enterprise that is still intact.
In the event you’ve received a adequate enterprise, when you have a monopoly newspaper, when you have a community tv station — I am speaking of the previous — you recognize, your fool nephew might run it. And if you happen to’ve received a very good enterprise, it does not make any distinction.
STAAR Surgical’s enterprise mannequin isn’t so simple as Moody’s, however it’s easy sufficient such that even when a CEO who isn’t as gifted as Caren Mason is on the helm, the enterprise ought to nonetheless do wonderful. Just like a newspaper and a community TV station, STAA has a dominant place out there that it serves. And in contrast to a newspaper and a community TV station, STAA is backed by an enormous and rising tailwind of an growing variety of folks with myopia.
Caren Mason left CEO Thomas Frinzi a STAAR Surgical that’s in a significantly better form than when she first discovered it. STAAR Surgical is now flush with money, has low whole debt, and has a superior product that’s rising in demand in most of its main markets (China is up 38% year-on-year, India is up 37%, Korea is up 18%, and Japan is up 14%; North America area gross sales elevated 51% on account of gross sales development within the U.S. up 59% and Canada up 10%).
And STAA’s enterprise in China can be handed to CEO Frinzi on a silver platter. China is STAA’s largest income contributor in 2022 at 52% of internet gross sales, and since China has eliminated its zero-covid coverage pent-up demand from beforehand delayed procedures will certainly increase gross sales within the coming quarters. And with FDA’s approval of EVO ICL within the U.S. in 2022, U.S. gross sales of EVO ICL has skyrocketed and progress has been nice, with over 600 surgeons skilled and authorized to date.
I stand by the assertion I made in my earlier article that STAAR Surgical is a superb firm. It’s certainly not low-cost at $59.94 however it’s arguably buying and selling at truthful worth now if it might maintain a development fee of at the least 30%. Nevertheless, with a brand new CEO in cost, with the revised-down income steering for FY 2023, the decrease anticipated income and earnings development prospects (however nonetheless double-digit development nonetheless), and the decline within the deliberate expenditure on gross sales and advertising and marketing, and analysis and growth, each as a share of whole gross sales, I’ll say that an funding in STAA now could be riskier than it was only a quarter in the past, so extra warning reminiscent of applicable portfolio sizing is critical.