Soothing Those Aging Bones

08/05/2008 12:00 am EST

Focus: STOCKS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Ian Wyatt, editor-in-chief of Growth Report, finds a small orthopedic device company that should profit from baby boomers’ pain.

Gainesville, FL-based Exactech (Nasdaq: EXAC) is a leading manufacturer of orthopedic implants—devices used to replace or repair movable joints such as knees, hips and shoulders. 

With those millions of aging baby boomers putting lots of additional pressure on their joints and other "movable parts," Exactech's products stand to be in huge demand for quite some time. Exactech markets its replacement joints in the United States and Australia in addition to more than 30 markets in Europe, Asia, and Latin America.

The demographic trends are skewed in Exactech's favor. By 2030, when the first baby boomers reach 84, the number of Americans over 65 will have grown by 75%, to 69 million. That means more than 20% of the population will be over 65, compared with only 13% today. More than 35% will be over 50.

And let's not forget that an increasing number of these baby boomers are becoming, well, portlier. Is it little wonder, then, that bone and joint diseases account for half of all the chronic conditions in people over the age of 50?

And is it little wonder that orthopedics is a growth industry? According to Knowledge Enterprises, an industry consultant, the worldwide market for orthopedic products was estimated to be $28.9 billion in 2006, an increase of 11% from the previous year.

Exactech’s business fortunes have closely tacked the trend. From 2003 to 2007, revenue grew at a 12% compound annual growth rate to $124.2 million, net income grew at 5.5%, and EPS grew at 5%. In the first quarter of 2008, revenue increased 34.4%, knee implant sales increased 17.7%, [and] hip implant sales grew 15.6%. Lower down the chain, growth is even more encouraging. [Other businesses are growing even more rapidly.]

And Exactech is holding its own [against the industry giants]. Indeed, its products are competitive and it's continuously pumping out innovative ideas while remaining focused on improving the existing business lines. What's more, Exactech can procure business in markets that can't avail themselves of the economies of scale demanded by the big boys.

Given the persistent demographic trends and Exactech's demonstrated ability to capture market share, annual earnings per share growth should average 25% over the next three years and at least 9% thereafter. EPS discounted to the present at a 12% rate produces a $39 per share price target, which we think is entirely reasonable. (The stock closed at around $27.50 Monday—Editor.)

We also think it's reasonable because of management's self-interested commitment to value creation. Forty-one percent of Exactech's stock is owned by insiders, ensuring that management and outside shareholder interests are aligned.

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