ICU Medical: Reducing Our Moat Rating to None Due to Ongoing Smiths Integration Uncertainty

We are reducing ICU Medical’s ICUI moat rating to none from narrow, largely to account for uncertainty around the firm’s economic profitability related to the Smiths acquisition. In conjunction, we have raised our Uncertainty Rating to High from Medium. The moat reduction shortens our modeled length of economic profitability, which brings our fair value estimate to $177 per share, down from $195 previously.

Recent quality and operational issues at Smiths, which started even before it was purchased, greatly reduced ICU’s gross margin after the acquisition. These issues have required additional spending to fulfill customer orders. While some of these issues are temporary, the end game for margins remains uncertain. Furthermore, with pandemic lockdowns over, suppliers have resumed their normal marketing activity, and Smiths’ lingering quality and fulfillment issues raise the risk of losing clients until they are fully addressed. In addition, management has recognized that roughly one tenth of Smiths original revenue was lost during the transition, which may have been due to poor visibility when purchased.

At the segment level, infusion systems remains moatworthy but it is overshadowed by impaired margins and lost revenue at the firm level, and we have decided to rule on the cautious end of this moat rating until those problems are permanently fixed. We think the consumables segment remains competitively vulnerable, and the vital care segment is largely commoditized.

We are maintaining our Standard Capital Allocation Rating for ICU Medical based on its sound balance sheet, fair investment record, and mixed shareholder distributions, although investors should know that ICU stands on the weak end of the Standard category after the Smiths acquisition. The acquisition added to the firm’s infusion pump portfolio, strengthening the segment’s switching costs—which we appreciate strategically, but the price appears large and the execution was negative, as well.