OMI: Is Owens and Minor a Major Bargain?
This is a reprint of my 25 August 2008 RealMoney column.
Owens & Minor (OMI) is the nation’s leading distributor of medical and surgical supplies to the acute-care market. It’s also a health care supply-chain management company and a national direct-to-consumer supplier of testing and monitoring supplies for diabetics.
Most of its revenue is derived from fees based on a percentage of the value of products distributed, but 32% of its revenue is contracted on the basis of the company’s costs. Its primary competitor in medical/surgical distribution is Cardinal Health (CAH) . In the direct-to-consumer diabetes supply business, its largest competitor is Liberty Medical, a subsidiary of MedcoHealth Solutions (MHS) .
Owens & Minor has been establishing a track record of earnings surprises, beating analysts’ estimates in each of the last three quarters. Analysts are beginning to reward the company with higher full-year 2008 and 2009 estimates, which now stand at $2.36 and $2.64, respectively. By contrast, estimates for MedcoHealth have been steady, and those for Cardinal are falling. Owens is expected to post higher revenue growth than its peers, and that may account for the differential in earnings trends.
Over the next three to five years, the consensus among analysts is that OMI earnings per share can grow 18% annually. Much of this growth is likely to come from acquisitions, such as its recent agreement to purchase privately held Burrows. Given the uncertainties surrounding the timing of acquisitions and the fact that they will likely require additional investor financing, my valuations are based on a more conservative 10% growth rate, in line with the company’s sustainable growth rate. Combined with a 1.7% dividend yield, the double-digit total return potential isn’t too shabby — and the acquisitions could provide a boost to that, if and when they materialize.
Better still, the growth has a backstop in the form of strong cash-flow generation. Over the last 12 months, Owens & Minor generated free cash flow (cash flow from operations less expenditures on capital assets and software) of $190 million — a whopping 10.5% of the company’s market capitalization. Over the last year, most of the free cash flow has been used to pay down debt. Long-term debt was $369 million in June 2007, but it declined to $221 million by June 2008. The debt reductions free borrowing capacity for larger acquisitions, or alternatively the company could turn to share repurchases as debt levels decline further.
For a company growing 10% annually, I believe the 10.5% free cash flow yield represents a huge risk premium. By contrast, the free cash flow yields at Medco and Cardinal are less than 5%. I don’t see why a company with this growth profile should yield more than 6%, which would still be twice the current yield on five-year Treasuries and a premium to the cash flow yields of its peers. Were it to trade at a 6% free cash flow yield, the shares would be at $75, which is 65% above the current level.
That’s not the kind of valuation change I’d expect to see overnight. Over the next few years, however, I believe it is likely. Even if it took five years for the valuation to converge with that of its peers, the total return would exceed 20% per year.
Overnight or over time, those kinds of returns look good to me.
Disclosure: At the time of publication, William Trent has no financial position in the companies mentioned in this article.
