Monday, June 17, 2013

Cooper Companies Has Good Long Term Prospects

Everyone loves a defensive growth story, and there aren’t many better companies in the category than Cooper Companies (NYSE: COO). In general, ophthalmology is an industry that can grow irrespective of the economy. Within this, Cooper has its own mix of earnings drivers with which it can generate superior industry growth.

It is a compelling mix. In fact, so much so that the stock has gotten away from this investor’s hopes for a buying opportunity. In summary, the recent results were pretty good in a relatively weak environment, and the full year EPS guidance hike is seeing the stock higher as I write. Is there more to come?

Super Cooper

Before going into the details, here is a summary of the updated full year guidance versus the previous company estimates.

The key changes are the raising of EPS guidance (I have bracketed) and a $10 million lowering of revenue guidance for Coopervision and Coopersurgical respectively. The former is largely due to currency effects and the latter is due to the kind of softness with medical surgery that others like Johnson & Johnson (NYSE: JNJ) have reported in the quarter.  In fact, Johnson & Johnson explicitly stated that hospitals had reported that surgical procedures were currently running at levels below the rate that they had predicted for 2013. As for the full year currency effects on Coopervision, we got an idea of how pervasive they are in the current quarter whereby 11% growth at constant currency turned into only 7% reported growth.

So while the reduction to revenue expectations was slightly disappointing, the increase in the EPS guidance was well received. There was no change to free cash flow (FCF) guidance.

Essentially Cooper is succeeding in its aims of trading up customers to its (higher margin) silicone hydrogel lenses (which now make up 43% of Coopervision revenues) and towards its one-day modality. The latter generates 4-6x the revenue of ordinary lenses and 3-5x the profit. All of which is good news because if we go back to the previous set of results Cooper outlined its intention to increase capital expenditures by $90 million in order to accelerate the sales expansion of its silicone hydrogel based lenses. The recent results suggest that it was a good move.

Long term growth looks assured

Going forward the long term opportunity for Cooper is obvious. The company is catching up with its rivals in terms of its silicone hydrogel lens penetration, and the benefits of a one day modality to the consumer are obvious. Moreover, unlike some of its rivals, Cooper is not encumbered with the strategic difficulty of missing out on lens care sales (one day lenses don’t require care) because it is expanding its one day sales. Furthermore it can expand its private label sales, and the growth potential in the emerging world is obvious.

However, the story isn’t just about Coopervision. Its surgical division is a strong FCF generator, and the strategy is to make further acquisitions in the space in order to leverage its sales infrastructure. Putting all these elements together should ensure long term growth and, more importantly, at a rate in excess of industry growth.

What the industry is saying

Cooper reported that the market only grew 4% (at the bottom of the expected 4-6% range) and that it expected it to grow at 4-6% for the rest of the year. The good news is that Cooper is able to grow in excess of these numbers. A quick look around the industry shows some sluggish conditions. Its biggest rival is probably Johnson and Johnson, and it reported only 1.6% constant currency growth for its vision care range; thanks to currency effects its international vision care was down 4.4%.

It was a similar story with Novartis’ (NYSE: NVO) Alcon unit. Ophthalmic pharmaceuticals sales were up 5%, but vision care was only up 3% and, in line with what Johnson & Johnson and Cooper said, its surgical revenues were soft with only 2% growth being recorded. Alcon is not a huge part of Novartis' revenues, but it is of strategic important to the company and complements its generic and OTC pharmaceuticals activities.

However, the big news in the industry in the quarter was Valeant Pharmaceuticals' (NYSE: VRX) agreement to purchase Bausch & Lomb for $8.7 billion. It is certainly a busy time for Valeant as it attempts to integrate Medicis as well as prepare for Bausch & Lomb. Interestingly Valeant disclosed that Bausch & Lomb grew revenues at 9% last year (although this includes its surgical segment). Valeant talked about generating $800 million in cost synergies by the end of 2014, but this does not mean it won’t be investing in eye-care. In fact Bausch & Lomb’s strength in emerging markets is complimentary to Valeant’s North American focus, and eye-care, dermatology and aesthetics are good bed-fellows in terms of strategic development. We can expect increased competition as a result of this deal.

I would summarize the industry background as being stable but slightly weaker than might have been expected.

Where next for Cooper Companies?

In conclusion Cooper Companies is a very attractive company that can achieve good revenue and margin growth even if the economy slows. In my opinion its evaluation should command a premium over the market but, as ever, the question is how much do you want to price in?  The ‘defensive’ sector has certainly led the market this year, and many stocks within it (particularly food stocks) are starting to look toppy to me.

As I write this, Cooper Companies trades on $120 and an enterprise value (EV) of $5.85 billion. Interpolating from my table above, this puts it on a forward PE ratio of 19.3x and a forward FCF/EV yield of only 3.1%. As much as I like the stock I am still going to truculently go away, sit in a corner and mumble that it’s too expensive right now while patiently waiting for a dip.

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