Long Getinge – profit from panic

Best time to buy is when people run. Good example is Getinge, a Swedish medical devices company. The company has a good track record – strong medical devices brand, good organic and acquisition growth.

On March 7 the company reported a profit warning. The warning was affected by the FDA inspection findings that raised issues with company’s quality management systems in certain production facilities. The company announced that it has retained consultants to remedy the situation and that the associated costs would amount SEK 125 mil (USD 20 mil) per quarter for a period of six to seven quarters. These costs will cause approximately 10% reduction in EBITA. The company also announced the work will not affect organic sales growth, as the issues are related to quality control system not production problems.

The result: the company shares went down by 27% from 236 to 172 SEK, wiping out USD 2.1 bln of its valuation.

If one believes the company that there should not be material production and brand perception distortions, and the total costs to remedy the situation will amount to USD 120 – 140 mil spread over 6 -7 quarters, than the valuation drop of USD 2.1 bln is not justified.

The reason for the drop was investor concern whether the company is not underestimating the issues raised by FDA.

In this I found very helpful research by Michael Jungling of Morgan Stanley. Under the Freedom of Information Act They requested from US FDA details of the inspections. They obtained two forms from two inspections from US and German facilities. In both cases the FDA issues relate primarily to administrative matters and not production quality issues. Specifically he mentions the following examples:

1. Corrective and preventive action and/or results have not been adequately documented

2. Procedures have not been adequately established to control product that does not conform to specific requirements

3. Procedures that define the responsibility for review and the authority for the disposition of nonconforming product have not been adequately established

I believe this is comforting despite the fact that not all forms have been obtained and reviewed.

The next big event for Getinge was supposed to be the Investor Day on May 27. The company was planning to announce its 2014 financial targets (Getinge already announced on 16 April its 2014 full year organic revenue growth of 4.3% beating consensus of 3.8%, but did not announce details on estimated profitability). It also stated that it would provide more information on its costs efficiency program that was “deemed to be highly favourable”. One week before the investor day the company postponed the event till the FDA situtaion is clarified. The share price was recovering towards the investor day, but went down to low 170s after this announcement.

I believe there are two FDA outcomes: (i) fine, (ii) temporary production disruption. If the FDA situtaion would require production closures, it would have already happened. I therefore see production clousures risk as low. The question is how big the fine might be. It is hard to estimate the fine, however it is hard to imagine, that it could be anywehere the 2.1 bln loss in mkt value the company suffered. If the fine is deemed not high enough we can expect the surge in Getinge share price. Such move than might be reinforced be the cost savings announcement that the company already promissed to the investors. The share price is still 21% down from the pre FDA announcement levels. The next event is the 16/10/2014 when Getinge is scheduled to report the results. It is quite possible that the date might bring some good news for Getinge investors.

Disclosure: I am long GNGBF.

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