Mark Odendahl 00:00
Welcome back to the Industries in Motion podcast from RBC Capital Markets, where we'll be exploring what's new and what's next in today's fast moving markets and industries to help you stay ahead of the curve. Please listen to the end of this podcast for important disclaimers. My name is Mark Odendahl and I'm Head of US Capital Markets Research. Let's get into today's episode. Today we're really happy to introduce Shagun Singh. Shagun is our new Med Devices and MedTech analyst. She joined in late 2021 from Wells Fargo and has been publishing research on the street for 16 years. We've been really happy with Shagun’s start. She initiated on a number of names and we'll talk about this later in the podcast. She also initiated on some significant market modeling in the med device area. Shagun welcome to the podcast today and thank you for the great start at RBC.
Shagun Singh 01:16
Thank you, Mark, and really happy to be here today.
Mark Odendahl
Well, let's get into it. You cover all the major med devices companies’. What are some of the major trends in the sector right now?
Shagun Singh
Yeah, I think macro has been a key focus of late and the key themes have been around procedure volume recovery, and inflation and supply chain. I think procedure volume recovery remains the number one driver for the sector. Our latest check suggests that volume recovery is occurring. It is more apparent in the higher acuity procedures such as cardiology, those with higher pain burdens like spine and less apparent in lower acuity or elective procedures. The recovery is much different this year than what we have seen in the past due to nursing staffing shortages, that is putting a limit on capacity. This suggests that the recovery will be more gradual in 2022. If we are playing recovery, we like care setting exposure or those with exposures to ASCs or hospital outpatient departments, as opposed to elective procedure exposure. This is because staffing shortage is much less acute in those settings. The second topic that we've been really focused on is inflation and supply chain, which is a headwind as a spillover effect of COVID, especially as it relates to freight. So higher oil prices, I think oil prices have been up about 38% in Q1. Raw material inflation across the board, especially with respect to electronic components, and direct and indirect labor costs. I think the most important thing here is, Mark, that shifts and procedure volume recovery will be a more meaningful driver for the sector a relative to shifts in inflation supply chain dynamics.
Mark Odendahl
That's interesting. And so let's drill down on that. So as we look at the first half of earnings for the med device sector, how do you think these dynamics will play out as we start to see earnings from the med tech sector into 2022?
Shagun Singh
Yes, absolutely. I think, Mark, there will be a lot of moving parts. I think inflation and supply chain commentary will be negatively biased. But the impact will not be equal across all companies. I do expect freight costs to be a headwind for the entire coverage due to higher oil prices. Raw material costs to really vary by company and direct and indirect labor costs to be a more manageable headwind. I am especially worried about chip shortage arising out of China. And if it could be a headwind to sales and not just margins for certain companies. We have published a proprietary piece looking specifically at the impact of chip shortage to our coverage this week, and also a piece on pricing power that I think is worth taking a look at. I think FX will be a headwind as well this quarter. But Mark, I would characterize a lot of these factors as transitory creating near term headwinds, I think Q1 stock shifts should create a buying opportunity in some of the higher quality names because procedure volumes are continuing to recover and there is strong underlying demand for health care overall.
Mark Odendahl
So one of the parts of your franchise that we've been very impressed with is your visibility and your participation at major medical conferences. You've been very busy over the last month or so. Could you let us know what events you've been attending and what you've been learning?
Shagun Singh
Absolutely, and it's been really nice to be finally attending these medical meetings in person. We were CRT, ACC, SAGES and AOS in the past month, focused on the orthopedic cardiology and robotics space. My key takeaways really are that the underlying fundamentals of the sector remain robust, driven by the demographics and still very under penetrated end market. We do have proprietary market models and product models to support this. I also noticed that there is a major shift in industry trends around digital innovation, smart implants, with sensing technologies that can really monitor patient recovery for years, AI driven procedural integration trends that leverage the latest in technology, such as AR, VR and MR and enabling technologies such as robotics, where we may be at an inflection. This was a trend that began pre pandemic, it was limited by it, and we may be on the other side of it again in 2022 and beyond. But overall, my sense is that Q1 moving parts will fall behind us and fundamentals will be back in focus. I think that trend is already occurring right now, to some extent.
Mark Odendahl
Yeah, and you touched a lot on a lot of that digital innovation in our recent department wide RBC Imagine report, where we look at disruptive and transformational moves in the sectors that we cover. So let's, let's talk about the some different subcategories. So when you initiated at RBC, you spent a lot of work on some of these subcategories. Could you talk to us, in your group… what are some of the areas that are experiencing the fastest growth? And what are some of the products driving that growth?
Shagun Singh
Absolutely. I think there are multiple medical device submarkets that are growing rapidly. Transcatheter aortic valve replacement is a mid-teens growth market where low risk indication is yet to be penetrated. Because 50% of procedures are still done with the surgical approach. Transcatheter mitral and tricuspid therapies is a new leg of growth, a market that is poised to increase from 1 billion at the end of 2021 to 5 billion by 2028 and there are several products in focus and catalysts that we have discussed in latest notes. I think surgical robotics is a very interesting market growing in the double digits year over year and still has a penetration of just about 2% globally. We expect line of sight procedures to go from 6 million to 20 million, and there is still much room for further expansion there. A very attractive market that is at an inflection. In fact, we expect robotics to become the standard of care across several areas, not just surgical, but recon… so, hips and knees as well as spine. Elsewhere, there are double digit growth markets within cardiology, such as left atrial appendage closure, and even outside of cardiology, such as peripheral vascular, and neurovascular or stroke. Diabetes also comes to mind it is a highly underpenetrated market that is growing in the double digits. Worldwide continuous glucose monitoring market stands at about 7 billion in 2021. And it is poised to grow at a double digit clip to 12 billion by 2025. So I think overall what I would say is that the underlying fundamentals continue to be really strong and there are several attractive submarkets within the medical device space.
Mark Odendahl
So if we step back and look at some of the bigger drivers some of the demographic or economic drivers, can you talk about that?
Shagun Singh
Absolutely, I think there is there a lot of positive tailwinds for the sector. Firstly, there is rising demand for global health care. There is the ageing demographics. There is also the rising global middle class, the middle class in China and India is growing rapidly and they are demanding greater access to health care. Then there is the medical device end markets where treatment rates are still very low. There are also newer technologies that are driving mixed shift in established end markets with a shift to minimally invasive approach such as in robotics. And disruptive technologies will continue to drive growth even in mature end markets. So orthopedic comes to mind, which is a mid two, which is a low to mid single digit growth market. But with sensing technology in orthopedics, we could expect higher growth as well as robotics and remote patient monitoring. I think there is strong demand for hospital capital spending and latest technologies. And we expect a continued focus on internal R&D and M&A as companies drive category leadership.
Mark Odendahl
Let's follow up on something you just said. What are your thoughts on M&A in the sector? It's been a… it's been a space that has rolled up over the years. Do you expect that to continue?
Shagun Singh
Absolutely. And I think M&A will continue to be a very important theme among medical devices, as companies drive that category leadership strategy. And just to point out, Mark, this is a shift from prior trends that was towards building the breadth of portfolio and drive a bundling strategy. And Medtronic acquisition of Covidien comes to mind. Our hospital CFO checks increasingly suggests that hospital customers are looking at best of breed companies with the ability to scale. So we do expect technology driven tuck in M&A to continue to be a driver of top line organic growth. And I think what is also interesting is that valuations have come down quite a bit for smid cap names. And there continues to be opportunity across public and private medical device names.
Mark Odendahl
Thank you very much, Shagun. That was an excellent rundown in the med tech device area. We learned a lot on the demographic drivers, we learned a lot on some of the emerging categories and emerging products that are driving your company's going forward. We appreciate your time today.
Shagun Singh
It's been a pleasure, Mark. Thank you so much for having me.
Mark Odendahl
What else lies ahead in today's ever evolving markets and industries? We'll be keeping track right here on Industries in Motion. Until then, thank you for joining us on this episode recorded April 7, 2022. To make sure you subscribe to industries in motion wherever you listen to your podcasts. If you'd like to continue this conversation or you're interested in more information, please contact your RBC representative directly or visit our website at www.rbccm.com/industriesinmotion for further insights. We really enjoyed speaking about the medical device industry today. Thanks for your time.