Merit Medical Systems

Moat: 2.5/5

Understandability: 3/5

Balance Sheet Health: 4/5

Merit Medical Systems is a medical device manufacturer specializing in interventional, diagnostic, and therapeutic procedures, with a global sales presence.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Let’s dive into the business details:

Merit Medical Systems (MMSI) designs, manufactures, and distributes proprietary medical devices, primarily used in interventional, diagnostic, and therapeutic procedures. A significant portion of their revenues come from products used in cardiology and oncology, with the rest coming from endoscopy and other medical devices. They have a considerable global presence with sales made in the United States, the Netherlands, China, Ireland and Brazil.

Here’s how their revenues break down across operating segments, based on their latest quarterly results (Q1 2024).

Segment	Q1 2024 Revenue (in millions)	YoY Growth
Cardiovascular	$234.5	12.8%
Peripheral Intervention	$161.1	13.9%
Endoscopy	$51.3	16.2%
OEM	$61.1	-2.7%
Total	$507.9	10.0%

Cardiovascular: This segment offers products used in cardiology, peripheral vascular, and interventional radiology applications. This includes products for angiography, angioplasty, and vascular access procedures.
Peripheral Intervention: This segment provides products that treat diseases of the peripheral vascular system. This includes devices used for embolization, thrombectomy, and atherectomy.
Endoscopy: This area focuses on products used in endoscopic procedures. These products facilitate diagnosis, treatment, and imaging within the GI tract, biliary tree, and other areas.
OEM: This segment includes customized products and components produced for other medical device manufacturers.

The company has a diversified geographic presence. A key strategy has been expanding into international markets, particularly in Europe, the Middle East, Africa, and Asia Pacific. Geographically the main revenue contributions are from the U.S. (64% of their revenues in 2023) which has a stable growth rate, and international markets (36% of their revenues in 2023) are showing a strong growth rate, with more than 15% growth year on year. In addition to organic growth, acquisitions and new product developments play key roles.

Now, let’s assess its moat:

MMSI’s moat is, at best, narrow, earning a rating of 2.5/5. Here’s the breakdown:

Switching Costs:
- MMSI’s customers, primarily hospitals and healthcare providers, face moderate switching costs. The need for approvals, familiarity, integration into existing systems, and clinician preference creates stickiness. However, these factors aren’t high enough to provide total lock-in. There are competitors in almost every segment the company operates in, and switching is not difficult if competitors’ products offer a clear cost or quality benefit.
Intangible Assets:
- While some products carry patents and trademarks, they are not uniformly strong throughout the portfolio. Also, their competitive advantage doesn’t stem from a particularly strong brand. The company is not very popular to the end consumers, and they purchase medical equipment purely based on specifications, cost, or hospital standards rather than brand loyalty. As such they do not have pricing power like some of the strongest brands, like Coca-Cola or Nike.
Economies of Scale:
- MMSI has a good-sized distribution network, especially in the US market. However, it does not have a truly dominating market share in almost any segment, and therefore the economies of scale is limited. Competitors are often able to capture a good amount of sales at similar costs.
Network Effects:
- The network effect is not applicable to MMSI. The company doesn’t operate a network that becomes more valuable as users join the network, like eBay or other similar companies.

Moat Justification: The main aspects of the competitive advantage are coming from switching costs and economies of scale stemming from distribution. The company can leverage its existing distribution channels to offer a variety of new products in a convenient and cost-effective way. However, this does not create enough of a moat to give pricing power and keep out new competitors. This moat is quite fragile.

Let’s look at what risks the moat could be facing, and the business resilience:

Regulatory Changes: Changes in FDA and international regulatory policies (such as drug approval processes, clinical trial standards, etc) can affect product approval timelines, or could make the cost of entry prohibitively high. This can be a double-edged sword, since stricter regulations may make it difficult for smaller players to compete, and therefore consolidate market share.
Technological Disruption: The medical device industry is constantly evolving. New technologies, like robotic surgery, AI, and new diagnostic procedures, have the potential to disrupt MMSI’s product offerings. They will need to make sure they are able to compete with up and coming startups, and also maintain a fast pace of product development.
Competition: Intense competition from companies with existing market shares can lower the company’s margins and also the market shares. The fact that they are in every major market means that they compete with the big companies such as Medtronic or Abbott and also a lot of private companies specialized in specific areas.
Supply Chain Issues: Disruptions in the global supply chain such as geopolitical tensions, trade disputes, logistics issues could impact the manufacturing and distribution, resulting in increased costs. They source parts and raw materials from a variety of suppliers, so any disruption there will severely hamper the operations.
Product Liability: Medical device companies are constantly susceptible to product recalls and litigation, which are expensive and can harm the brand.

The company also has a very high amount of acquired intangible assets which carry the risk of impairment charges, if the acquisition doesn’t perform well.

Business Resilience Despite the above, MMSI demonstrates some business resilience:

Diversified Product Portfolio: MMSI operates across a range of medical specialties, which reduces its reliance on any single product line or procedure. If a product faces regulatory or technological challenges, then their business doesn’t simply collapses.
Established customer relations: The company has worked with many large hospitals and healthcare provides for a long time, creating a stable base of operations. The switching costs for their customers to other providers does provide a little bit of a safety net.

Now let’s talk about financials:

MMSI’s financials show a generally positive trend with consistent revenue growth, but there are some areas of concern:

Revenue Growth: Revenues have grown steadily, but this has mostly come from organic growth which has slowed down in recent years. There has been good acquisitions which have further added to the revenues, and they plan to expand more in international markets.
Profitability: There has been good profitability with gross profits usually over 30% for the past few years, and net profit margins have ranged from 5 to 10%.
Balance Sheet: A look into the company’s balance sheet reveals that there are some concerns about debt and liquidity. The company has seen high levels of leverage, and debt levels are rising due to recent acquisitions. This could prove detrimental if the debt interest rate rises a lot.

Here’s a snapshot of the company’s key financials from the latest 10-Q report: | Metric | Three Months Ended 03/31/2024 ($ Millions) | Three Months Ended 03/31/2023 ($ Millions) | |————————————|—————————————-|—————————————–| | Net sales | $507.9 | $461.6 | | Cost of goods sold | $177.4 | $167.5 | | Gross profit |$330.5 |$294.1 | |Selling, general, and admin. expenses |$211.9 |$194.6 | |Research and development |$78.4 | $62.7 | |Total operating expenses |$394.8|$323.9| |Operating income |$113.1 |$139.2| |Net income |$23.5 |$25.8|

And key ratios:

Ratio	Q1 2024	Q1 2023
Gross Profit Margin (as a %)	65.1%	63.7%
Operating Margin (as a %)	22.3%	30.2%
Earnings per share (diluted)	0.44	0.46
Return on Equity (annualized)	10%	13.9%

Looking at the income statement, we can see the company has strong growth in the overall top line revenue (which was up 10% year-on-year), however the operating profit has decreased. This is primarily due to higher operating costs and research and development expenses. Net income was also slightly lower.

Next let’s assess the balance sheet. | Metric | Dec 31, 2022 ($ Millions) | Mar 31, 2023 ($ Millions) | Mar 31, 2024 ($ Millions)| |———————————|————-|———-|———| | Cash and cash equivalents |$ 176.2 |$100.8 |$92.9| | Accounts receivable |$213.5 | $225.5 | $236.3 | | Inventories | $439 |$441.4 | $441.9 | | Total assets | $2,424.3 | $2,496.9 | $2,774.4 | | Total Liabilities |$1,165.8 | $1,225.3 | $1,331.9 | | Total equity | $1,258.5 | $1,271.6 | $1,442.5 | | Long-term debt | $821.9 | $809 | $835|

The balance sheet shows a generally strong position. In particular the company has a substantial amount of equity, but the debt position is a worry. Overall, the financials show the company is growing, but at the cost of profitability and with a relatively high debt position.

Here’s the understandability of the business:

Based on these factors, we will give a rating of 3 /5 on understandability:

The general idea of what MMSI does is relatively straightforward, they make medical equipment. It is also easy to understand their main markets, such as cardiology and oncology.
However, understanding their exact product pipeline, their contracts, as well as the different regulations are complex. Also, their financial data is quite complicated given the different geographic segments that they are operating in, the different tax laws and accounting rules, and the company’s several acquisitions, makes it a bit more complicated for an average investor.
The company’s acquisition history is complex. and involves a complicated interplay of finances, operational improvements, and strategic imperatives.

Finally, balance sheet health:

The company’s balance sheet gets a 4/5.

The company has very low cash, but large current assets like accounts receivable and inventories that cover short-term obligations.
There is a high level of debt (around $835 million of long-term debt). They have had a lot of acquisitions, which increased their debt position and intangibles.
Their debt is more than half of the company’s assets. They have to generate enough cash flows to pay these debts. They should also be careful in taking on new debt.

In recent events:

There has been discussions around the impact of the economy on their sales, with some fears about the impact of inflation.
The management team claims they are focused on organic growth, and this should bring positive results soon.
They also have been focusing on streamlining their operations to improve efficiency.
They are focusing on innovation with a solid pipeline of products.

Summary: In conclusion, MMSI has a narrow but somewhat durable moat driven by their distribution and switching costs. Their financials are improving, but the company still carries a relatively high amount of debt. Its revenue model is easy to understand, but diving into the complex financials of the company in different geographies is difficult.