April 22 Investment Digest Daily Alert
Today Dow Theory Forecasts Editor Richard Moroney recommends a stock from the medical device industry.
“Varian Medical Systems, Inc. (VAR $67 NYSE) supplies X-ray tubes that help doctors identify cancerous areas and oncology systems that beam radiation to treat the tumors. Demand for cancer-fighting equipment should rise going forward.
The World Health Organization’s International Agency for Research on Cancer projects the annual number of cancer diagnoses will exceed 21.3 million in 2030, versus 12.7 million in 2008.
“Varian grew both sales and earnings per share through the recession, even as U.S. hospitals tightened their capital budgets and patients postponed procedures. After surviving through several lean years, health centers should eventually ramp spending to replace aging equipment, though reductions in Medicare reimbursement rates could dampen demand in the near term. However, Varian collects more than half of its revenue outside of North America, and emerging markets offer solid long-term growth opportunities. The stock is rated a Long-Term Buy.
Business breakdown
“Varian sells hardware and software products that treat cancer (about 78% of sales), along with X-ray equipment (nearly 18%). The oncology and X-ray units boast similar gross profit margins, both exceeding 40%. But oncology’s profitability faces pressure from expansion in emerging markets, a trend unlikely to reverse any time soon. Profit margins for both units will also take a hit from the Affordable Care Act and the new 2.3% tax on medical devices that went into effect in January, though Congress may repeal the tax. Varian enjoys high sales visibility on account of its backlog. Up 11% to $2.8 billion at the end of December, the backlog represents nearly a year of revenue. Sales have risen by more than 5% in nine straight quarters, and cash from operations has climbed by at least 18% in four consecutive quarters.
“Free cash flow grew 32% to $438 million in the past year, pushing net cash above $5 per share. At least 90% of that cash is held overseas, and management says rather than paying taxes to repatriate those funds, it will consider taking on debt to maintain stock repurchases. Varian has approved the repurchase of 6.5 million shares, roughly 6% of outstanding shares. Since June 2010, Varian has decreased its share count 11%.
“Varian shares have slipped 1% this year, missing out on the 19% gain posted by the S&P 1500 health-care sector. At 18 times trailing earnings, the stock trades 6% below its three-year average. Varian also trades at 17 times estimated earnings for fiscal 2013 ending September, a modest 3% discount to the industry median. Yet Varian’s per-share profits are projected to rise 10% to $4.12 in fiscal 2013, outpacing the estimated 6% median growth for its sector.
Conclusion
“The next catalyst for the stock arrives on April 24, when Varian is expected to announce March-quarter earnings. The consensus calls for earnings per share to climb 10% to $1.02 per share on revenue of $758 million, up 5%.”
- Richard J. Moroney, CFA, Dow Theory Forecasts, April 22, 2013