Elective Bunion Procedure Deferrals Will Pressure Margins Yet Long-Term Demand Will Ultimately Endure

Catalysts

About Treace Medical Concepts

Treace Medical Concepts develops and commercializes specialized surgical systems for bunion correction and related foot and ankle procedures.

What are the underlying business or industry changes driving this perspective?

• Although the company has rapidly broadened its bunion portfolio to cover Lapidus fusion, minimally invasive osteotomies and great toe fusion, sustained surgeon preference shifts toward lower ASP minimally invasive procedures could keep revenue growth muted even as case volumes rise.
• While expanded training programs and a growing base of more than 3,100 surgeon customers support deeper penetration of bunion procedures, slower than expected cross adoption of Lapiplasty by new osteotomy focused surgeons may limit mix improvement and pressure gross margins.
• Although innovation pipelines such as Lapiplasty Lightning and the Percuplasty compression screw system aim to capture a larger share of reconstructive foot and ankle procedures, delayed commercialization or weaker than expected uptake could constrain future revenue acceleration.
• While management is tightening operating expenses and has already reduced cash usage and adjusted EBITDA losses, ongoing spending for medical education, litigation and salesforce expansion could postpone the timeline to sustainable earnings and margin expansion.
• Although a large pool of deferred elective bunion procedures and an aging, more active population should support long term procedure demand, prolonged macroeconomic pressure or persistent consumer deferrals may cap near and medium term volume recovery and slow improvement in revenue and earnings.

Assumptions

This narrative explores a more pessimistic perspective on Treace Medical Concepts compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Treace Medical Concepts's revenue will remain fairly flat over the next 3 years.
• The bearish analysts are not forecasting that Treace Medical Concepts will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Treace Medical Concepts's profit margin will increase from -22.9% to the average US Medical Equipment industry of 12.9% in 3 years.
• If Treace Medical Concepts's profit margin were to converge on the industry average, you could expect earnings to reach $28.5 million (and earnings per share of $0.42) by about December 2028, up from $-50.1 million today.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.2x on those 2028 earnings, up from -3.6x today. This future PE is lower than the current PE for the US Medical Equipment industry at 30.4x.
• The bearish analysts expect the number of shares outstanding to grow by 2.17% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.56%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistent secular shift in surgeon and patient preferences toward lower priced minimally invasive osteotomy procedures and away from higher ASP Lapiplasty could structurally cap average selling prices and slow top line expansion, limiting revenue growth and constraining gross margin over the long term.
• Macroeconomic pressure and softer consumer sentiment are already leading to deferrals of elective bunion surgeries, and if this trend persists or deepens, the company may struggle to convert its growing procedure opportunity into realized volumes, depressing revenue and delaying a return to positive earnings.
• Case volume growth is currently driven by newer systems with inherently lower pricing, and if cross adoption of higher value Lapiplasty and Adductoplasty by these new surgeon customers remains weaker than expected, mix will remain unfavorable and could weigh on both revenue and net margins despite rising volumes.
• Operating expenses continue to grow due to medical education, surgeon training, restructuring and litigation, and if efficiency gains and scale benefits fail to outpace this spending, the company may remain loss making for longer than anticipated, pressuring earnings and cash generation.
• The recent benefit from nonrecurring stocking distributor sales pulled demand forward into the current period, and if replenishment orders do not compensate for this dynamic as expected, future quarters could exhibit flat or declining sales, undermining confidence in the growth trajectory and negatively impacting revenue and earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Treace Medical Concepts is $4.0, which represents up to two standard deviations below the consensus price target of $5.47. This valuation is based on what can be assumed as the expectations of Treace Medical Concepts's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $7.5, and the most bearish reporting a price target of just $4.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $220.5 million, earnings will come to $28.5 million, and it would be trading on a PE ratio of 12.2x, assuming you use a discount rate of 8.6%.
  
• Given the current share price of $2.8, the analyst price target of $4.0 is 30.0% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.