Hospital Spending Fears Expose SonoSite

By Stephen D. Simpson, CFA | October 31, 2008 AAA

Sometimes you can do everything right and still end up on the wrong side of a trade. And that seems to be the case for small-cap medical technology company SonoSite (Nasdaq:SONO). While this producer of portable ultrasound systems has solid current growth and strong prospects for future expansion, investors have turned more cautious on this company.

Bright Summer Followed by a Bleak Winter
SonoSite reported that revenue grew 23% for the recent quarter, with U.S. revenue up 18% and overseas revenue up 30%. Gross margins improved slightly and operating income came in solid, as the company has transitioned past the point of covering ongoing SG&A expenses.

Medical technology companies like Intuitive Surgical (Nasdaq:ISRG), Varian (NYSE:VAR) and Stryker (NYSE:SYK) have faced some challenges as a result of the declining health of the hospitals market. While these companies have not reported significant problems in ordering trends, the combined credit crunch and economic downturn could undercut medical capital spending.

SonoSite management acknowledged concerns over a slowdown in the hospitals sector, but it appears that an availability of credit is not a choking point at this time. Instead, some hospitals are freezing spending across the board.

Although portable ultrasound systems are not expensive enough to require the same level of management oversight and hospital board review as other high-end imaging systems producers like General Electric (NYSE:GE), Royal Philips (NYSE:PHG) and Siemens (NYSE:SI), a spending freeze is still a spending freeze. Thus, even if hospital administrators have the budget for SonoSite systems, they may be forced to postpone actual purchases.

Bigger Problems Afoot?
SonoSite had little say about the recent departure of CFO Bernard Pitz, which was brought about "at the request of the company". It is unclear whether Pitz's departure is tied to the company's failed attempt to complete an acquisition, but a drastic change in upper level management and a failed acquisition both equal sour news for SonoSite.

Competition could be seen as an even bigger problem for the company, however. SonoSite has the unenviable task of competing with the aforementioned GE, Philips and Siemens - vastly larger companies that have substantially higher advertising and promotional budgets to rely on. Furthermore, SonoSite's competitors can offer bundled deals across a wide array of products, whereas SonoSite is limited to portable ultrasound. Smaller companies sometimes are nimbler and more opportunistic. However, they often end up getting squashed under the feet of giants, despite any strong suits.

The Bottom Line
Even if SonoSite's growth slows significantly in 2009, there is a substantial difference between "slow" and "stop". Shares of SonoSite stock trade at a price-to-sales ratio of about 1.6, which is well below the usual range for growing small-cap and mid-cap medical technology stocks of 3 to 6. While the company has more debt than is normal for a med-tech company, which likely will grow as a result of new accounting rules for convertible bonds, SonoSite is using its solid free cash flow to pay down some of its debt early. Thus, at only a few dollars above the 52-week low, and with ample growth prospects, SonoSite is worth a look for investors in the growth-at-a-reasonable-price crowd.

To delve more deeply into these topics, read Use Price-to-Sales Ratios to Value Stocks and Free Cash Flow: Free, But Not Always Easy.

You May Also Like

COMPANIES IN THIS ARTICLE
Related Analysis
  1. Stock Analysis

    MetLife Tagged as SIFI: What it Means for Your Portfolio? - Analyst Blog

  2. Chart Advisor

    Profit From Holiday Spending With This ETF

  3. Stock Analysis

    Varian Medical Systems Inc. (VAR): New Analyst Report from Zacks Equity Research ...

  4. Stock Analysis

    Inogen (INGN) Now a Strong Buy on Positive 2015 Outlook - Analyst Blog

  5. Stock Analysis

    Varian Eyes MeVis to Enhance Imaging Components Portfolio - Analyst Blog

Trading Center