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.

The following article is a reprint of my 26 August 2008 RealMoney column.

Since 2001, hospital stocks have been looking green around the gills. Shares of LifePoint (LPNT) , Universal Health Services (UHS) and Community Health (CYH) have pretty much gone nowhere. Tenet Healthcare (THC) and Health Management Associates (HMA) look even worse, having lost more than 50% of their value.

That may be about to change. As I have noted before, employment statistics show hospitals as being one of the few industries reporting significant hiring. Unfortunately, I believe the lean years have left analysts who are covering the stocks too shell-shocked to notice improving fundamentals.

Evidence of the high degree of skepticism can be found in a Forbes article published on Aug. 8, when LifePoint issued a positive earnings report and raised guidance. The article focused on declining admissions and fears that a sinking economy could increase bad-debt expense. JPMorgan analyst Dawn Brock was quoted as saying, “We are concerned about the sustainability of margins given the weak admissions growth, especially as we do not believe the company can continue to see bad debt improvement given the overall macro environment.” Stifel Nicolaus analyst Robert Hawkins said the company had done a poor job of managing its expenses.

Investors weren’t listening to the analysts. LifePoint shares soared 10% on the increased guidance and have held steady since. I believe the company’s strategy may finally get the shares out of their multiyear rut. If I’m right, the analysts covering the name will probably be the last to hear about it.

Better Than Its Price

LifePoint operates hospitals in non-urban communities in 17 states. Of the company’s 48 hospitals, 44 are in communities where LifePoint is the sole community hospital provider. Its strategy is to increase the services available at such hospitals to capture more of the revenue opportunity in these communities. On the recent conference call, LifePoint CEO Bill Carpenter said that “early deep dive hospitals have already through the first six months of the year met or exceeded their full year 2008 targets.”

Even after the 10%, rally the shares certainly don’t seem excessively priced. At less than 13 times the 2009 consensus earnings estimates, many would likely consider them cheap. Given that the company has exceeded earnings estimates in three of the last four quarters, the current consensus estimates could be too low. That would make the shares cheaper still.

The earnings also translate into strong free cash flow, measured as cash from operations less capital expenditures. Over the last 12 months, LifePoint’s free cash flow totaled $127 million, or 6.9% of the company’s market capitalization. With five-year Treasuries yielding barely more than 3%, that represents a pretty healthy risk premium, even before considering growth opportunities due to the company’s strategy.

Analysts expect LifePoint to increase earnings by 10% annually over the next three to five years, a rate that is in line with the company’s sustainable growth rate on the basis of fundamentals. Meanwhile, at 1.2 times book value, it is trading well below the industry average of 2.1 times.

If earnings grow as expected and the price/book multiple expands to the industry average multiple over the next five years, total returns could approach 25% per year.

Maybe by then the analysts will have caught up to the story.

This article is a reprint of my August 12 2008 RealMoney column.

Sometimes you have to wait for a bit of bad news to get a stock at the price you want. I think that is the case with Chattem (CHTT) , a leading niche provider of over-the-counter health care products, toiletries and dietary supplements.

Chattem’s brands include Pamprin, Gold Bond, Selsun Blue, Dexatrim and Bullfrog. About one-third of its sales are to Wal-Mart (WMT - Annual Report) stores. Chattem’s share price has fallen more than 10% since the company was forced to recall several Icy-Hot Heat Therapy products that were providing too much heat and causing burns. With that episode resolved, I think the lower price represents a buying opportunity.

By focusing on niche market segments outside the core product areas of larger consumer product companies, Chattem has built brand equity and leveraged its distribution capabilities, which has resulted in increased profit margins. The strong brands also allow for multiple brand extensions, such as Gold Bond Restoring, Cortizone Intensive Healing, Icy Hot PM and Aspercreme Heat.

When Johnson & Johnson (JNJ) bought Pfizer’s (PFE - Annual Report) consumer products division in 2007, regulators required it to divest certain brands. Chattem swooped in. For $410 million, the company added ACT, an anti-cavity mouthwash/mouth rinse; Unisom, an OTC sleep aid; Cortizone-10, a hydrocortisone anti-itch product; Kaopectate, an anti-diarrhea product; and Balmex, a diaper-rash product. The new products increased Chattem’s revenue base by more than a third.

While such acquisition opportunities arise only occasionally, Chattem’s focus strategy and brand extensions should allow for strong organic growth as well. For 2009, the company expects organic sales to grow at a high-single-digit rate or higher. As the acquired JNJ products reached their anniversary this year, Chattem has continued to exceed earnings expectations.

For the full-year 2008, analysts have ticked their estimates up slightly, and the consensus for 2009 per-share estimates has risen from $4.47 to $4.54 over the last month. Chattem management expects the firm to generate $90 million to $95 million in free cash flow this year, which amounts to a 7.25% free cash flow yield based on the current market capitalization.

At more than twice the yield on five-year Treasuries, the cash flow offers investors both a risk premium and a margin of safety. The cash is also being put to good use. So far this year, the company has repurchased 418,000 shares at an average price of about $63 a share. The company also reduced its total debt load by $50 million over the last year. The risk premium is further enhanced by the 15% earnings growth expected over the next three to five years. That growth rate is below the sustainable rate based on ROE, and given the company’s history of share repurchases, I think there could be room for upside EPS surprises.

I don’t see the need for such a high free cash flow yield when the cash flow is growing so quickly. When you combine 15% annual growth with a 6.3% terminal free cash flow yield (100% of the current Treasury yield), you get the equivalent of 18.5% annual returns over the next five years.

Investors have awarded Chattem an average P/E ratio of 20.7 over the last five years. If shares trade back up to that historical multiple, then you are looking at 30% to 34% share price appreciation, based on 2009 estimates. That multiple of the $4.54 consensus 2009 estimate suggests the shares could increase 34% to $94 a share over the next year or so.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article. 

My latest column is up at RealMoney.

DaVita (DVA) is a leading provider of dialysis services in the U.S. for patients suffering from chronic kidney failure, also known as end-stage renal disease, or ESRD. As of Dec. 31, 2007, the company operated or provided administrative services to 1,359 outpatient dialysis centers serving about 107,000 patients.

The total ESRD market is estimated at 340,000 patients and is growing 3% to 4% annually. DaVita and its largest competitor, Fresnius Medical Care (FMS) , together control 65% of the dialysis market.

Over the last 12 months, DaVita’s free cash flow (cash flow from operations less capital expenditures) has been nearly $250 million, or 4.4% of the company’s market capitalization. When combined with the 15% expected growth in earnings over the next three to five years, the risk premium looks attractive. The free cash flow could also provide support to the valuation levels.

Though I’m not a technical analyst by trade, I also take comfort in the fact that it looks like DaVita stock may have bottomed in March, and that there is nearer-term support at the 50-day and 200-day moving averages — both of which are in the $52-$53 range. Those could be good spots for an initial trading stop or protective put options in case things go wrong.
Disclosure: At time of publication William Trent has no financial position in the companies mentioned in this article.

In the video feature, Best Trades Now: Healthcare, Energy & More, what does Edward Perks call “a tremendous performer”?

Canadian Oil Sands (COSWF) has been a tremendous performer, really driven by the oil-price performance the last several years.  Others, like Pfizer (PFE - Annual Report), have been a little bit tougher, a little bit more of a long-term value play, with the creation of new drugs there over time.”

- Edward Perks, Franklin Income Fund

My latest column is up at RealMoney.

Omnicare (OCR) provides pharmaceuticals and pharmacy services to a variety of health care providers. It also offers contract research services to drug manufacturers. Earnings have been a bit rocky, but free-cash-flow yield and other valuation metrics make this stock worth a checkup.

The company’s primary competitor is PharMerica (PMC) , and it lists its peers as AmerisourceBergen (ABC) , Parexel (PRXL) , Pharmaceutical Product Development (PPDI) , PSS World Medical (PSSI) , and Sunrise Senior Living (SRZ) . There is also some competitive overlap with retail pharmacy companies such as Walgreens (WAG) and CVS Caremark (CVS) .

The long-term care industry is poised to benefit from aging boomers. However, investors won’t need to wait to reap the benefits. As I’ve pointed out recently, health care facilities are one of the few areas of the economy seeing employment growth. Presumably, they aren’t hiring for the sake of hiring.

Omnicare is trading at a reasonable multiple of 15 times this year’s earnings estimates. Given that the company has hit a speed bump, that doesn’t seem particularly cheap, but the stock begins to look enticing when you look at measures beyond earnings.

Even after deducting cash paid for acquisitions, however, the $280 million in free cash flow offers a healthy 8.75% yield.

Omnicare is currently trading below book value, which seems silly given that the industry average price-to-book multiple is above 2.0. Meanwhile, analysts expect the company to grow approximately 15% annually over the next five years. That estimate is in line with the company’s sustainable growth rate based on fundamentals.

Even if the company only grows at the 10% level forecast by the most pessimistic sell-side analyst, the low valuation could boost total returns to 20% or more annually if the price-to-book multiple converges with the industry average.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

My latest column is up at RealMoney.

We can all agree that the jobs report was pretty lousy. On a year-over-year basis, the growth in employment is barely staying positive.

However, as Jim Cramer likes to point out, there’s always a bull market somewhere, and regular readers probably know I like to use the economic reports as a source of stock ideas. Until they launch an “Economy ETF” (believe me, it won’t be long before somebody tries), that means sifting through the reports to find the industries and companies that are most poised to benefit from the prevailing trends. In this morning’s jobs report, that was pretty easy. According to the Bureau of Labor Statistics report, only five industries are showing statistically significant job growth:

• Hospitals
• Ambulatory health care services
• Nursing and residential care facilities
• Oil and gas extraction
• Pipeline transportation

I’ll bet you noticed the same pattern in those industries that I did.Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

Options trading: Rebecca Darst says which dental technology firm saw “unusually bullish call activity”?

Darst also reported that options traders seem to be circling around some dental technology plays.

“It’s interesting, and I say that this is a sector play simply because we saw some unusually bullish call activity in Align Technology (ALGN), which is the company that makes Invisalign invisible braces. This was followed up yesterday by some interesting activity in Sirona (SIRO), which is a maker of hygienic equipment and dental imaging systems. We saw it straddle sellers yesterday in the July 25 contract, so people taking a premium on dental technology, that’s an area to watch.”

Align doesn’t show up on the screens I follow. Sirona has high earnings momentum, but is ranked neutrally for earnings quality, price momentum, free cash flow and return potential.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

In March, Bernie McGinn was on the money with his Ford pick. Early this month, what pharma stock did he recommend?

Also on his list is Pfizer (PFE - Annual Report) although the drug giant’s shares have been going in the other direction lately.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

My latest column is up at RealMoney.

I dissect the jobs report to see which industries are showing the best/worst growth in new hiring, on the thesis that companies in these industries may present investment opportunities.

The fastest growing industries are restaurants, hospitals, mine services, machinery, and oil & gas extraction. The worst were transportation equipment and a plethora of housing-related sectors.

Disclosure: At time of publication, William Trent owns shares of Starbucks (SBUX).

Disclosure: Author is long Starbucks (SBUX) at time of publication.