Leeds-based Surgical Innovations (SUN:AIM) is in an interesting phase of its development as it continues to move forward from a series of profit warnings last year.

Keyhole solutions

The company designs and manufactures solutions for minimally invasive surgery, also known as keyhole surgery. These procedures can reduce scarring and decrease recovery times in hospital. The instrumentation manufactured by Surgical Innovations makes it easier for surgeons to view and access parts of the body precisely during operations.

Surgical Innovations has historically specialised in ‘resposable’ technology, which comprises a mixture of parts that are designed for single use and for reuse. Parts of the instrumentation that are liable to contamination are single use only, while other elements can be reused for up to 200 procedures.

All of its products are sold through distributors with 75% exported overseas and the remainder sold in the UK. One of its core selling points is that it manufactures in the UK, which is seen as appealing to distributors resistant to low-cost medical instruments from China.

Partnership plan

Surgical Innovations wants to form new partnerships with original equipment manufacturers (OEMs) in product development and sourcing to accelerate the development of its solutions.  One of its key partners is wound care dressing tech developer Advanced Medical Solutions (AMS:AIM) which markets the LiquiBand Fix8 after it was manufactured by Surgical Innovations.

LiquiBand Fix8 offers a controlled and specific delivery of a tissue adhesive to reduce the risk of post-operative complications.

In November, Surgical Innovations announced the acquisition of laparoscopic (keyhole) instruments business Surgical Dynamics for £360,000 in cash. The acquired business develops fully disposable products using vertical moulding and currently has several products in its pipeline, including grasper heads and scissors.

Specialising in both resposable and single-use instrumentation will help Surgical Innovations to access a wider spread of countries with different requirements. The UK and Germany are more likely to invest in resposable technology, while Italy, Greece and Spain are more inclined towards single-use products due to the cost of sterilisation in those countries. The company hopes to capture market share using Surgical Dynamics single-use pipeline.

Eric Burns, analyst at broker WH Ireland, highlights that Surgical Dynamic’s precision metal injection capability will be adopted at the Leeds facility. This will help to reduce waste and speed up the manufacturing of certain components. The analyst also notes the deal will bring in some ‘potentially interesting intellectual property’ to Surgical Innovations’ existing portfolio.

Into the black

In 2015 the medical tool maker issued several profit warnings and racked up losses, resulting in the resignation of chairman Doug Liversidge after sales in the US didn’t materialise as expected. Turnaround specialist Nigel Rogers was appointed executive chairman in October 2015 to take the company forward.

He has already helped the firm return to profitability in the first half of 2016 with adjusted EBITDA of £0.5m, up from £0.24m for the whole of 2015. Gross profit has also improved, jumping nearly four-fold from £217,000 in the six months to June 2015 to £809,000 in the same period a year later.

The company also moved from a net debt position of £1m at the end of 2015 to a net cash position of £0.43m.

Investors have been buying into the recovery, helping the share price nearly double in a year from 1.6p to 3.12p, although there have been bouts of volatility along the way.

At a site visit attended by Shares, Rogers and managing director Melanie Ross acknowledge the firm’s troubled past and believe it is on the road to recovery following management changes.

One of the root causes of its previous issues was unrealistic expectations as it used to stock 12 months worth of inventory. To combat this, the firm decided to mothball production and now has a healthier stock holding of two months, which also reflects stronger demand and turnover.

Where next?

The Brexit vote is seen as both a challenge and an opportunity in the future. The company has experienced export-led revenue growth after the shock result. Management expects its margins to benefit from currency fluctuations as the majority of its exports are priced in local currencies while the cost base is primarily priced in sterling.

Increasing medical device regulation and barriers to entry are concerns. They could result in higher costs and longer time to market, which can affect future pipelines and profitability. Despite these potential roadblocks, Surgical Innovations says it is up for the challenge.

On the surface the shares look expensive at 34.7 times 2017 earnings but this reflects the fact the business is in the early stages of profitability. We are impressed by the management and think patient investors could be rewarded at 3.12p. (LMJ)

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