Friday, January 4, 2013

Cooper Companies is a Good GARP Candidate

One of the things that I love about investing is coming across a company like Cooper Companies (NYSE: COO). It is exactly the sort of stock that-if told about it now- would leave most investors saying ‘of course!  But why didn’t I hear about it before when it was a great value and it made this big move?’

While it would be easy to fall into this negative mindset, I think we should think positively and do three things.  First, realize that this means that there are probably other great stocks out there that are as attractively priced as Cooper was a year ago. Second, research Cooper and keep it on a watch list or future reference. Third, ignore the price chart and stick to asking yourself if Cooper is a good value now.

Introducing Cooper Companies

Cooper is a health care company with a rough mix of 80% of revenues coming from Coopervision and 20% from Coopersurgical.

Coopervision is a manufacturer of soft contact lenses, an industry that has truly proved itself to be recession resistant and currently generating mid-single digit growth globally. Indeed I looked at Allergan (NYSE: AGN) in an article linked here and it’s easy to see from that article that its forecasts are relatively predictable. Rather like Cooper, Allergan is generating super-industry growth. I think its cash flow generation plus potential upside from the approval of Botox in new indications as well as the expansion of sales for spasticity and migraines means it should trade at a premium.

Novartis (NYSE: NVS) is also active in the space with its Alcon unit, but its growth rates are currently tracking pretty close to industry averages.  Turning back to Cooper, its growth rates are higher than those of the industry primarily because of growth in its silicone hydrogel (more oxygen gets to the eye ensuring more comfort) based lenses Avaira and Biofinity. Revenue for these silicone hydrogel-based products grew 24% in the quarter and now make up 39% of Coopervision’s revenues and 31% of total company revenues, and they also represent the immediate growth opportunity for the company.

Moreover, another thing in Cooper Companies favor is that it has the potential to grow geographically, whereas an already global player in eye care, such as Johnson & Johnson (NYSE: JNJ), has less growth potential because it has an established global market share. It also can generate growth through moving into new ranges of wear, with the two-week range market (currently dominated by JNJ) being cited as a target.

In summary, Coopervision has good long term growth prospects through a combination of geographic, demographic, and product mix (most notable its silicone hydrogel range), which should enable it to generate above-trend growth in an industry that already has solid single digit growth prospects.  In addition the trade up to silicone hydrogel based products is likely to  increase profitability and margins in future.

With Coopersurgical, it is a story of integrating the Origo acquisition and utilizing its international sales channels to generate growth outside of Coopersurgical’s traditional geographies.

Current Trading and Guidance

Having discussed longer term prospects, it’s time to discuss current trading and guidance. I’ve summarized what Cooper forecast for 2013 in the table below.

I would recommend that interested parties bookmark this guidance and come back to it as the year progresses.  The current stock price is $94.53 with a market cap of $4.67 billion and an Enterprise Value (EV) of $5.03 billion. Capital expenditures are rising (depressing free cash flow) in an effort to support expansion of silicone hydrogel based product sales, but the good news is that should lead to margins expanding throughout 2013.

As for current trading, thanks to Hurricane Sandy earnings were lowered to the tune of $0.02, with a particular impact on Coopersurgical. Indeed, earnings growth in the segment was reduced to 2% when an organic rate of 4%-5% would have otherwise been recorded. In addition, there was a $0.07 impact from an inventory contraction in the quarter.  Frankly it is always questionable as to whether this is due to a genuine inventory contraction or a fall off in end demand. In this case I think the company deserves the benefit of the doubt because it doesn’t strike me as a marketplace with particularly volatile end demand.

Where Next For Cooper Companies?

The mid-point of guidance has the stock on a forward PE of 16.2 and forward FCF/EV of 4.2%, neither of which look particularly cheap. However, the stock offers a high degree of solidity in its earnings and a combination of high single digit top line growth with low teens EPS growth. Margins and underlying cash flow conversion should improve throughout 2013, so the stock might start to look cheap if it hits its guidance.

As ever the decision lies with the conscience of the individual stock picker. For what it’s worth I think Cooper Companies is a great investment but slightly overvalued now, and would prefer to try and get it at a discount. Whether it gets there or not is another story. Nevertheless, this is a strong stock for the watchlist.

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