Here's a Bone You Can Pick

05/21/2013 9:45 am EST


Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

The shares of this company have been hit hard by selling pressure unrelated to the strength or weakness of the stock itself, which may mean a nice bargain, writes Taesik Yoon of Forbes Investor.

More often than not, when you come across a stock that's down 15% during a period of market strength, as shares of Orthofix (OFIX) were from mid-October 2012 to mid-March, there's usually a pretty good reason for it.

For OFIX, the primary catalysts were weaker-than-expected sales growth in the second half of 2012, and guidance that suggests this trend will likely continue in the current year. You could probably add in the negative impact of the medical device excise tax instituted by the Affordable Care Act this year.

But what would explain the additional 15% drop in the stock since then? Even given the more cautious view on global economic growth that has materialized, this sell-off seems excessive. As such, we believe it's more reflective of the unusual weakness in small-cap stocks during the current market slide than any material change in business fundamentals.

OFIX is a diversified, global medical device company focused on developing and delivering innovative repair and regenerative solutions to the spine and orthopedic markets. The company's products are designed to address the lifelong bone-and joint health needs of patients, helping them achieve a more active and mobile lifestyle.

OFIX derives 74%, 8%, 4%, and 2% of its sales from the US, Brazil, Italy, and the UK, respectively, with the remainder generated from various other regions.

The company's primary customers are musculoskeletal medical specialists and group purchasing organizations (GPOs), which are hospital organizations that buy on a large scale.

OFIX operates two segments. The Spine segment, which was responsible for 67.5% of 2012 sales, provides Spinal Repair Solutions (31.8% of 2012 sales) including implants designed for use in cervical, thoracic, and lumbar fusion surgeries, as well as vertebral body replacements and interbody devices. Spinal fusion is the permanent union of two or more vertebrae to immobilize and stabilize the affected portion of the spine.

The segment also offers Spinal Regenerative Solutions (35.6% of 2012 sales), which are stimulation products that enhance the growth of bone tissue following surgery.

OFIX's Orthopedics segment accounted for 32.5% of 2012 sales, and covers treatment solutions for a variety of orthopedic conditions unrelated to the spine. Its fracture repair products, for instance, consist of fixation devices designed to stabilize a broken bone until it can heal.

The segment makes devices that treat congenital bone conditions, such as angular deformities (e.g. bowed legs), or degenerative diseases, as well as conditions resulting from previous trauma. Lastly, Orthopedics offers regenerative products that are designed to enhance the success of a procedure by facilitating bone fusion.

Net sales for the fourth quarter of 2012 fell 9% (8% in constant currency) year-over-year to $112 million. Spine revenue was down 3.7% to $75.7 million, as Spinal Repair Solutions sales were flat at $36.3 million and Spinal Regenerative Solutions sales, which were negatively impacted by sales force turnover related to OFIX's Corporate Integrity Agreement, declined 7.1% to $39.4 million.

Orthopedics revenue dropped 18.2% (15% in constant currency) to $36.4 million, primarily due to mandatory price reductions for public hospitals in Italy, cancellation of reimbursement by the government on its Physio-Stim bone growth stimulator in France, and a delay of surgeries by government hospitals and insurance providers.

With OFIX now trading at its lowest levels since December 2011, and at a price-to-forward-earnings multiple well below its five-year historical average, we don't think the stock will stay at its current level for long.

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