Cooper Companies Offers Great Long Term Prospects

In a world where investors make knee-jerk reactions to the latest quarterly earnings reports, it's sometimes difficult to focus on the long term. In the case of the soft contact lens industry, Foolish investors are faced with an industry with pretty secure long-term growth prospects. The only significant players are Johnson & Johnson and Novartis'  Ciba unit, with Cooper Companies  coming in third. Meanwhile, Valeant's  2013 acquisition of Bausch & Lomb puts it in fourth place. Cooper is the closest to a pure eye-care play among them, and it presents an interesting proposition for long-term buy-and-hold investors.

Cooper Companies' long-term growth
According to independent analysis, the soft contact lens industry is intended to grow at a rate of nearly 6% from 2012-2016. Indeed, Cooper companies reported that worldwide industry growth was at 5% this year. However, its CooperVision unit (around 80% of revenue, with CooperSurgical making up the rest) reported soft contact lens sales up at a more impressive 10% this year.

Essentially, CooperVision has the opportunity to grow faster than the market for four key reasons.

First, Cooper's silicone hydrogel (more comfortable, longer-lasting) lens sales grew at 19% (constant currency) in the fourth quarter, and are set to grow faster than the market. Moreover, since silicone hydrogel lenses make up 45% of its CooperVision's total revenue, Cooper can grow ahead of the market. In particular, its Biofinity (monthly, silicone hydrogel) lens has a growth opportunity in the US from customers trading up.

Second, industry wide single-use lens sales grew at 10% over the last 12 months, and CooperVision's single-use lens sales increased by 18% (constant currency) over the last year. They made up 21% of CooperVision sales in the fourth quarter. Going forward, Cooper is gearing up for an aggressive expansion of its MyDay (daily, silicone hydrogel) lens in Europe. Customers trading up to its single-day lens generate four to six times more revenue and three to five times more profit. In other words, Cooper has a revenue and margin expansion opportunity with MyDay, but it will take a few years to come to fruition.

Third, Cooper's specialty lenses (toric and multifocal) grew at 8% and 19% respectively in the fourth quarter, and now contribute nearly 40% of CooperVision revenue.

Finally, CooperVision's Asia sales grew at 11% (constant currency), and Cooper's management claims to have good growth opportunities with its Biofinity lens.

All told, it's not hard to see why analysts have the company growing revenue at more than 7% for the next few years.

Johnson & Johnson, Novartis and Valeant report
With a 43% share of the market, Johnson & Johnson is the No. 1 player, but its growth in the third quarter was a far more pedestrian 3.9% (constant currency). Moreover, its U.S. sales only grew 1.9%. Johnson & Johnson has a dominant market position in the two-week modality in the US and this may prove difficult to defend in future, as single-usage lenses gains popularity. 

Novartis operates Ciba Vision (25% of total market) out of its Alcon division, and its contact lens revenue was up 6% (constant currency) in the third quarter with growth driven, unsurprisingly, by its daily lenses and silicone hydrogel lens called AirOptix. Meanwhile, Valeant's Bausch & Lomb (9% market share) launched a one-day lens this year, but the parent company's main focus is on integrating the eye-care company and cutting costs. Indeed, Valeant is expected to reduce Bausch & Lomb's workforce by up to 15% going forward, while it seeks to expand internationally.

In a sense, Cooper's growth prospects (single-use, silicone hydrogel and international expansion) are nicely mirrored in what its rivals are saying too.

Cooper's bumpy growth
While Cooper's prospects look assured, the growth ahead won't be in a straight line. For example, management was very clear on the conference call that it was willing to invest in building out capacity for the growth of MyDay. According to CEO Robert Weiss:

 it is unlikely we will be making profits on MyDay in the next several years with the intent of continuing to develop that franchise, continuing to drive down cost of goods... ...capacity increases behind the product once we come to the U.S. and then... ...other markets around the world

Ultimately, it's not clear how this will affect profitability over the next few years. Moreover, international expansion comes at a cost, and Cooper predicts capital expenditures at a historical high of $200 million (nearly 12% of projected revenue) for next year.

A look at its historical performance demonstrates that Cooper can grow revenue in a recession (note its 2008-2010 performance) and its adjusted free-cash flow (calculated by assuming capital expenditure is equivalent to depreciation) is quite strong.

Sources: Company presentations, author's estimates.

Time to buy Cooper Companies?
Cooper's aim is to hit 25% operating margins by 2018. Assuming it does so, and revenue grows at 7%, then operating income is likely to be $560 million or 71% higher than it is now. In other words, operating income looks set to grow in excess of 11% a year compounded.

That's not astonishingly cheap for a company generating around 4.4% of its enterprise value in adjusted free-cash flow. However, Cooper is a relatively recession-resistant company, and Foolish investors should be willing to pay a premium for this quality. It's a good stock for long-term investors, but don't expect the ride to be plain sailing all the way.

Johnson & Johnson Now Relying on Pharma

Health care giant Johnson & Johnson (NYSE: JNJ  ) recently delivered a mixed set of quarterly results that produced more questions than answers. It's hard to be too critical of a company that beats estimates and raises full-year guidance, but there are a few considerations to ponder.

Yet again, the stand-out performer in the quarter was its pharmaceutical division. However, the underlying performance in its consumer and medical devices and diagnostics divisions contained some warning signs. Moreover, whenever pharmaceutical stocks are analyzed the usual approach is to estimate the future value of its pipeline, rather than focus on current earnings. The market should do the same here.

Pharma (40.1% of sales) stands out

While it's pleasing to see an increase in revenues of $523 million (3.1%), the pharma division contributed $634 million of that figure. Ultimately, pharma offset a reduction of $141 million in medical devices and diagnostics revenues and a paltry $30 million gain from consumer products. In other words, the non-pharma divisions (60.5% of revenues) saw their revenues fall by $111 million on a combined basis.

The pharma division is rapidly expanding sales of some of its newer drugs like Stelara (psoriasis), Xarelto (anti-coagulant), Zytiga (castration-resistant prostate cancer), and Invega Sustenna (anti-psychotic). In fact, these drugs contributed $572 million of the $634 million in increased sales in the pharma segment.

Going forward, Johnson & Johnson has high hopes of developing sales of Invokana (type 2 diabetes) although it may face competition in future for its leading treatment Remicade (rheumatoid arthritis). Naturally, it will vigorously defend its Remicade patents, especially given that the therapy represents 24% of its pharma sales.

Consumer products (20.5% of sales)

Operational sales actually rose 2% (and 4% excluding divestitures), but currency effects reduced reported growth to just 0.8%. In addition, this is the year that Johnson & Johnson planned to reintroduce 75% of the consumer brands that were affected by product quality issues. Indeed, two of the affected brands, Tylenol and Motrin (painkillers), were cited as "positive contributors" in the quarter. While their contribution is an obvious plus, it suggests that the underlying performance within consumer products is weak.

There was even some discussion of consumers trading down to store brands. Frankly, this wouldn't be a surprise because the likes of CVS and Walgreen (NYSE: CVS  ) have been aggressively expanding their in-store brand sales. Moreover, the drug stores are likely to keep pushing generic versions of pharma companies' over-the-counter (OTC) and prescription drugs.

Ultimately, growth in the consumer segment will rely on emerging markets, as the U.S. mass market consumer remains challenged by a weak economy.

Medical devices & diagnostics (39.4% of sales)

Orthopedics make up a third of the division's revenues, and unfortunately they only grew 1.1% operationally in the quarter. Despite the long-term growth prospects coming from aging population, there is a note of caution going forward. On the conference call, the management cited pricing competition primarily in the trauma segment in the U.S. In addition, pricing in U.S. orthopedics remains an issue as pricing declines of 3%, 1.5% and 4% were declared for hips, knees and spine solutions, respectively.

Incidentally, this is pretty much in line with what Zimmer (NYSE: ZMH  ) said in its last results. Zimmer saw pricing down 1.3% in the second quarter. Knee pricing declined 1.4% with hip pricing down 2.1%. In a foretaste of what Johnson & Johnson would say, Zimmer had outlined on its conference call: "Competitive pressures, most notably in the United States, slowed our Trauma growth for the quarter, but were mitigated by the company's consistently strong performance in overseas markets."

The worry is that more intensive price competition will extend beyond the trauma market and increase pricing headwinds in the U.S. orthopedics market for all the leading players.

Elsewhere, its eye-care numbers were somewhat disappointing with US growth of only 1.9%, and international operational growth at 4.9%. Contact lens specialist Cooper Companies (NYSE: COO  ) sees the global lens market growing at 4%-6% this year, but for the second quarter running it recorded only 4% growth. Given that Johnson & Johnson' s overall operational growth was only 3.9%, it's reasonable to worry that Cooper's growth might continue at the low end of its targeted range.

The bottom line

The pharma division is firing on all cylinders, and looks set to continue in future quarters. However, there are some warning signs in the other divisions. It's unreasonable to expect all its divisions to be performing well at the same time, but the trend of pharma outperforming has been here for nearly a year now.Much depends on the future pipeline.

All told, the stock looks close to fair value. A forward P/E of around 16.6 times earnings isn't especially cheap for a stock forecast to grow earnings at 6%-7% rate over the next few years. The current dividend yield of 2.9% will attract income seekers, but otherwise the stock looks pretty fairly valued at $91.

Cooper Companies, Great Prospects, Expensive Stock

When it comes to investing, sometimes it's best to start with the obvious and look for companies that have the potential to slowly grow. Contact lens specialist Cooper Companies  (NYSE: COO  ) is one such stock, and it's definitely worth taking a closer look at it.

Cooper Companies growth prospectsCooper reports numbers in two separate segments. CooperVision is a soft contact lens manufacturer generating 80% of revenues. CooperSurgical generates 20% of revenues, with two-thirds coming from surgical devices, and one-third from its fast growing fertility treatment products.  I'm going to focus on CooperVision.

Cooper's management is on record as expecting the soft contact lens market to grow at a 4%-6% clip this year. The bad news is that, for a second quarter running, the worldwide market only grew at 4%. This suggests that market demand is not as strong as it could be.

The good news is that CooperVision managed to grow its sales by 11% over the last 12 months, and there are a number of reasons why it can continue to grow.

First, its silicone hydrogel lenses (more comfortable, last longer) revenues now make up 43% of CooperVisions total. They grew at 22% (constant currency) in the last quarter, and Cooper can expect to generate more growth in the future from customers "trading up" to these lenses.

Second, Cooper's management never tires of pointing out that a customer trading up to its single-use (or one-day) lenses generates four to six times more revenue and three to five times more profit. In other words, there is ample room for growth in earnings and margin growth from expanding one-day sales. For reference, its single-use sphere revenues only make up 21% of CooperVision revenues (17% of total company), and they grew at 9% in constant currency in the last quarter.

Third, Cooper plans to move in on Johnson & Johnson's (NYSE: JNJ  ) dominant position in the two-week modality in the U.S. by marketing its own two-week lenses.

Fourth, Cooper has just launched its new branded one-day silicone hydrogel based lens called MyDay in Europe. According to the management, MyDay is "not going to be a major influence" next year because sales are building from a small base. It will take Cooper time to build up production capacity, but longer-term Cooper should have good prospects with MyDay. 

And finally, Cooper has plans to geographically expand sales of its leading Biofinity (monthly silicone hydrogel lenses). Moreover, it can cut costs thanks to not paying royalties, because sillicone hydrogel patents will expire in the U.S. in 2014 and globally in 2016.

Threats to growth?While Cooper has been growing, there is no guarantee that it will continue to do so. Indeed, Valeant Pharmaceutical's (NYSE: VRX  ) purchase of Bausch & Lomb suggests that competition will get tougher. For example, Bausch & Lomb recently launched a one-day lens. Moreover, Valeant has worldwide plans to generate synergies between its existing dermatology and eye-care products, and Bausch & Lomb's eye-care solutions. Valeant will surely invest in trying to expand Bausch & Lomb's international sales.

Similarly, Johnson & Johnson managed to accelerate growth in its vision-care segment to 5.4% operationally in the last quarter, and it cited its one-day lenses as one of "the primary contributors to operational growth." Cooper is not alone in recognizing the margin potential of one-day lenses, and Johnson & Johnson has a formidable distribution network in the kinds of emerging markets that Cooper wants to expand into.

A look at the numbersCooper has strong prospects, but it also has a strong valuation. Cooper's own EPS guidance has increased throughout the year.

Source: Company presentations.

However, its valuation has more than kept pace, and it now sits on a forward P/E of over 20 times the mid-point of its full-year EPS guidance. This looks expensive, but recall that Cooper has long-term margin expansion opportunities. Furthermore, a better gauge of its value is to look at its free cash flow potential. I've chosen to adjusted for the increased capital expenditure program it's undertaking right now. Cooper is investing in order to develop production capacity and to accelerate sales of its silicone hydrogel based sales. 

In the following table, I have assumed that capital expenditures equate to depreciation in order to give a better picture of underlying cash flow generation.

Sources: Company releases, author's estimates for 2013 and 2014.

My underlying free cash-flow estimates of $264 million and $290 million for the next two years indicate that Cooper continues to generate plenty of cash. However, these figures represent only around 4% and 4.3% of its current $6.65 billion enterprise value.

Cooper is an attractive company, but its valuation gives little room for error, and it operates in a very competitive market against giants like Johnson & Johnson and Novartis (Alcon). It's a great company, but one to keep on your watchlist for now.

Johnson & Johnson Looks Fairly Valued

Investors in health-care giant Johnson & Johnson (NYSE: JNJ) have been rewarded with a 30% share price rise in the last year. The health-care giant remains a go-to choice for investors seeking a relatively recession-proof stock with a decent dividend. However, investors need to ask themselves a few questions about its recent results: Can this share price run continue?  Does Johnson & Johnson still provide compelling value?  And what are the key takeaways for the healthcare industry from these results?

Johnson & Johnson delivers

The argument for buying Johnson & Johnson is based on the fact that its three big near-term factors depend on how its management performs, rather than purely on the economy. This means that the stock can appreciate even in a weak economy.

First, Johnson & Johnson has been trying reintroduce a number of over-the-counter (OTC) products that were taken off the U.S. market due to production issues. Second, its pharmaceutical division has several new drugs with which it can develop sales. Finally, the successful integration of orthopedic company Synthes in its medical devices and diagnostics division will create earnings growth in a weak medical spending environment.

A checklist of these three factors would conclude that the company is well on track.

The company's plan to reintroduce 75% of those lost consumer brands by the end of 2013 was confirmed in its recent second-quarter results.  U.S. OTC sales were up 17.4% in the quarter, and although they only currently compose 7.9% of total consumer sales, the marginal increases in sales and profits will make an impact in future quarters.

Furthermore, its pharmaceutical division has delivered strong performance, with a 12.9% rise in constant-currency sales in the quarter. The standout performers within pharmaceuticals included newer drugs like Stelara (psoriasis), Incivo (hepatitis C), Xarelto (anti-coagulant), Invega Sustenna (anti-psychotic) and Zytiga (castration-resistant prostate cancer), all of which recorded sales growth at around 50% or more in the quarter.  In addition, its biggest drug, Remicade (rheumatoid arthritis), which contributes nearly 24% of its pharmaceutical sales, saw sales rise an impressive 10.3% in the quarter.

Lastly, the Synthes acquisition is working well. Indeed, J&J's overall growth in the medical devices and diagnostics sector was 12% in constant currency, largely thanks to Synthes.  Excluding the acquisition, the division would have reported sales growth of just 0.5%. It’s clear that the acquisition is helping Johnson & Johnson generate growth within a difficult part of the health-care industry.

It’s all in the price

The problem for investors wanting to buy in is that the market now seems to have priced these three factors into the share price. Compare Johnson & Johnson's price-to-cash flow multiple with its price chart:

JNJ Price to Cash Flow TTM data by YCharts

The stock hasn’t traded on a price-to-cash flow multiple of around 20 since 2005-2007. A cursory glance at the chart would reveal that the share price struggled to appreciate in that period. On the basis that it currently trades on that valuation, I would argue that much of the good news is already priced into the stock. Furthermore, analysts have earnings growing in only the mid-single digits for the next two years, and I’m not sure I’m keen to pay 24.5 times earnings for that kind of growth profile.

Winners and losers from Johnson & Johnson’s results

It’s always fascinating to read between the lines of Johnson & Johnson’s results and pick out indicators for other companies’ prospects. On the positive side, investors in eye-care specialist Cooper (NYSE: COO) will be interested to hear that Johnson & Johnson recorded 5.4% operational growth in its worldwide vision care business, and specifically cited daily lenses as an area of growth.

This indicates strength within the eye-care market, and should be good news for Cooper Companies, since one of its key aims in 2013 is to increase its one-day modality sales. Cooper’s one-day lenses generate three to five times more profit than its monthly lenses. Moreover, it is more of a pure-play on the increasing popularity in one-day lenses, because it doesn't sell lens-care solutions.

On the other hand, two losers from this report could be medical device company Covidien (NYSE: COV) and radiation oncology specialist Varian Medical Systems (NYSE: VAR).

Covidien has generated much of its growth in recent years from surgical device appliances within its energy and endo-mechanical divisions. Indeed, it’s a leader in the minimally invasive surgery market. Covidien’s supporters (and I’m one of them) will always point out that its solutions are relatively low-ticket, and they demonstrate a tangible way for hospitals to reduce costs via achieving better patient outcomes.

On the other hand, Covidien is still exposed to the volume of surgical procedures in medical centers, and in its conference call, Johnson & Johnson outlined that hospital and surgical procedures are flat to negative.

Turning to Varian Medical Systems, this company definitely is a high-ticket solution provider, and could suffer disproportionately if there is a buyer’s strike in the hospital and medical center market. There is a SWOT analysis of the company in an article linked here which outlines its prospects for 2013. Johnson & Johnson talked of the negative impact of macroeconomic conditions on its medical device sales, and robotic surgery appliance manufacturer Intuitive Surgical (another high-ticket solution provider) has already disappointed in this earnings season.

Moreover, in its conference call, Johnson & Johnson described the hospital capital expenditures market as being in recession for 10 to 12 consecutive quarters. All of these events are signs that Varian may find its customers more reluctant to spend in 2013.

The bottom line

Johnson & Johnson has pretty much priced in most of the good news, and it’s hard to see how the stock can appreciate much from here. The stock has had a great run, but now it’s time to wait for a pullback.

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.