5 Reasons to Buy This Health Care Stock -- and Why to Avoid It
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 is one such stock, and it's definitely worth taking a closer look at it.
Cooper Companies growth prospects
Cooper 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 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 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 numbers
Cooper has strong prospects, but it also has a strong valuation. Cooper's own EPS guidance has increased throughout the year.
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.
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.
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The article 5 Reasons to Buy This Health Care Stock -- and Why to Avoid It originally appeared on Fool.com.Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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