Saturday, March 16, 2013

Cooper Companies Equity Analysis and Research

Anyone looking for a defensive growth stock for their portfolio should at least add Cooper Companies (NYSE: COO) to their monitor list. If you are underwhelmed by my intro then I have had the desired effect! This is a great company and it has lots of upside drivers to its earnings forecasts but it’s hard to argue that the stock is a great value. Nevertheless if you are willing to be a bit more generous than me with valuation and pay a premium for its high visibility (pun intended) and quality of earnings, then COO could be the stock for you.

Copper Companies Analysis

In case anyone is not up to speed on Cooper I would recommend reading this article as a brief primer because I want to get straight into the detail.

The recent earnings were a bit ahead of estimates but as ever, the key is the guidance.

Eagle eyed followers of the company will note that a few things have changed since the previous guidance. I’ll deal with each point in turn.

  • The lower-end of Coopervision (and total) revenue has been raised $10 million
  • Gross and operating margins expectations have been hiked 50 basis points
  • The mid-point of capital expenditures has been raised by $90 million but free cash flow guidance was only lowered by $35 million

I’m reading the revenue guidance hike as a reflection of expectations following the pull forward of capital expenditure plans. Essentially Cooper is accelerating investment in rolling out its silicone hydrogel one day lenses. The thinking behind this is that its competitors are believed to have also increased investment and Cooper is already behind the market in terms of trading up its customers to silicone hydrogel. It simply cannot afford to be tardy on doing this and investors should welcome the plans. By way of reference only 40% of its Coopervision revenue comes from silicone hydrogel so there is an opportunity for margin expansion in future.

Its chief competitor is Johnson & Johnson (NYSE: JNJ), which has been more focused in growth in Japan for its growth in one day lenses. The Japanese are known to be fastidious in cleanliness and one-day lenses are ideally targeted at their preferences. Incidentally the cultural differences don’t stop there. The US has a major market for two week lenses (where Europe tends to have one day or one month) and Cooper is taking more aggressive steps in this market, which is currently dominated by JNJ. Cooper needs to play catch up because JNJ recently reported 6.4% growth in worldwide vision care sales. This is ahead of industry growth and is partly a consequence of JNJ being able to successfully shift customers to shorter modalities.

Moreover there was no adjustment to its forecast of $1.3 billion in free cash flow over the next five years. Analysts on the conference call seemed to miss the point that the free cash flow forecast was not lowered by the same amount as capital expenditures were raised. This implies that underlying cash flow conversion is doing better than previously expected.

As for the hike in margins unfortunately the position is somewhat distorted because COO renegotiated its royalty agreement with Novartis’ (NYSE: NVO) Alcon unit. For reasons of commercial confidentiality the nature of the change wasn’t outlined so it is hard the reasons for the change in the quantum of margins. Alcon is also a key competitor of Cooper and its growth seems to be in line with the industry. Alcon represents around 18% of total revenue for Novartis and the company and it made two small acquisition in 2012 in order to support this growth platform. However they were on the surgical side and Novartis is also very strong on the ophthalmic pharmaceuticals side. In other words, vision care is not primary focus.

Cooper Companies Equity Analysis

Here's a brief summary of what investors should be thinking about the long term:

  • Growing penetration of its higher margin silicone hydrogel lenses by convincing customers to trade up
  • Margin expansion from shifting customers to a one day modality (which generate 4-6 times revenue and 3-5 times more profit)
  • Taking market share in the two week modality in the US
  • Territorial expansion with silicone hydrogel
  • Expansion in key markets like China and Eastern Europe

Putting these together it’s not hard to see a bright future for COO and investors should be willing to pay a premium for a company whose end markets only tend to drop a percentage point or two in a recession.

Is Cooper Companies a Stock To Buy?

This ultimately boils down to what you are willing to pay for this sort of stock. As attractive as it is I’m not sure I am ready to pay an EV/Ebitda multiple of over 14 for this company. Moreover the free cash flow forecast of $1.3 billion over the next five years implies that it will generate around 4.5% of its enterprise value annually over the next five years. I would argue that this makes the stock pretty fairly valued at this price, but I’d hope to be the first into this stock if it dipped meaningfully from here.