Interest rates rocketed higher this past year, having an outsized impact on industries that have a large number of small cap stocks. Small caps are often either not profitable yet, or even if they are, have large capital requirements and borrowing needs. And as rates rose, those borrowing needs became a lodestone around the neck of small companies.
One sector that felt this acutely was the medical devices sector. Like pharmaceuticals and biotech, medical devices is made up of some large companies, but also has a very big cohort of small companies doing cutting edge research and development. But, as the interest rate cycle seems to be peaking, it’s time to revisit this sector and one of its beaten down small cap members, Surmodics (SRDX).
Surmodics (SRDX) started out making coatings for medical devices that could be placed inside the human body without causing infection or having other adverse impacts. The company still produces those coatings for other device makers, but has expanded their offerings into their own internal devices around vascular interventions. As in, they make devices to clean out your arteries of the plaque buildup you get as you grow older.
Other than the fact that they are currently doing well, we’ll talk numbers in a minute, they have a great product pipeline in an underserved market, and have products on the cusp of FDA approval that should start to positively impact the bottom line in 2024.
The market for vascular intervention, where most of Surmodic’s products sit, is growing at a 26% CAGR (compound annual growth rate) over the past 3 years. Despite the new weight loss drugs that are all the rage, we still are clogging our arteries. By their estimation, Surmodics has about 15% of that quickly growing $3.8 billion market.
In their latest earnings report SRDX presented a 12% YoY quarterly revenue increase, which translated to a 33% YoY revenue increase for fiscal year 2023. In addition to its strong growth, as reported by CEO Gary Maharaj, Surmodics has “more than $45 million of cash and investments to support our operations, and access to approximately $61 million in available debt capital to provide additional financial flexibility.”
One of the most exciting updates was around their SurVeil DCB product, which is designed to treat peripheral artery disease (peripheral as in arteries flowing away from the heart). The product received pre-market FDA approval in June of 2023, and should begin selling commercially in the first half of 2024. Initial units are already being shipped so that companies will be stocked with the device when final approval is received. SurVeil is designed to operate with a lower drug dose than other DCBs, and more efficiently with fewer side effects.
The market for DCBs is estimated at approximately $1 billion, and Surmodics believes it can take a substantial share of that market with their new device. The company has several other products, or product advancements, that should come online in late 2024-’25, that address similar sized markets.
Our POWR Ratings have SRDX rated a B, and number 8 in the Medical - Diagnostics/Research industry. It is very highly rated in the Quality component, but given its upcoming product releases, it’s no surprise its top rating of 97.65% is in the Sentiment component.
As interest rates stabilize and eventually turn lower next year, the medical devices industry as a whole will go from a headwind to a tailwind. Companies with a strong pipeline that have come through the recent rate cycle with their businesses little affected, like Surmodics, will have an out-of-the-gate advantage when that cycle turns. Picking up the stock here in the low $30s will provide a nice return if it trades anywhere near its $60 highs of late 2021.
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SRDX shares were trading at $33.23 per share on Tuesday afternoon, down $0.41 (-1.22%). Year-to-date, SRDX has declined -2.61%, versus a 20.63% rise in the benchmark S&P 500 index during the same period.
About the Author: Steven Adams
After earning a law degree cum laude with a focus on securities law, Steven worked as a Nasdaq market maker for a large broker dealer, and then as a trader for an arbitrage focused proprietary hedge fund. He subsequently worked as a consultant for a Fortune 500 consulting firm serving both government and commercial clients, including the NYSE, Prudential, FDIC, and NASA.
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