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.

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.

When I said it was too early to buy NBTY (NTY), unfortunately I didn’t mean a day or two early. The stock was up nicely this morning after an analyst upgrade.

Analyst Upgrades NBTY, Stock Surges: Financial News – Yahoo! Finance

Shares of NBTY Inc. surged Wednesday as an analyst upgraded the nutritional supplement maker, citing its solid sales and an attractive stock price.Edward Aaron of RBC Capital Markets said he is more comfortable with his NBTY estimates now partly because the Bohemia, N.Y.-based company recently reported improved sales. Last month NBTY said its January sales rose 6 percent, as strong wholesale results offset a weak retail environment.

As I said in the original article, though NTY looks fairly cheap so do most retailers and consumer companies. Unless we can get through another quarter without a significant earnings miss or downward revision it just seems too early to call a bottom here.

I still think there is better opportunity in names like Tupperware (TUP) or Coach (COH).

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

This article is a reprint of my March 4, 2008 RealMoney column

When I started looking at NBTY (NTY) when it showed up on one of my screens recently, I realized a good chunk of my typical Whole Foods (WFMI - Annual Report) bill was going to their products. NBTY makes vitamins, sport supplements and other products under the brand names Nature’s Bounty, Vitamin World, Puritan’s Pride, Holland & Barrett, Rexall, Osteo-Bi-Flex, Flex-a-min, Knox, Sundown, MET-Rx, WORLDWIDE Sport Nutrition, American Health, DeTuinen, Le Naturiste, SISU, Solgar, and Ester-C.

The health food shops where I pick up my supplements (which are served through NBTY’s wholesale segment) account for nearly half the company’s total sales. The North American Retail segment (457 Vitamin World and 80 Le Naturiste shops) provided 11% of 2007 sales, European Retail (626 stores under a variety of brand names) was 31% of company revenues and the Direct Response/e-commerce segment provided 10%.

These are clearly consumer products, clearly discretionary, and clearly at risk to a consumer slowdown. Given a price of just over ten times earnings and a 10% free cash flow yield, it is also clear investors are aware of this. However, there could still be some downside given that in 2000 valuations troughed at 8.8 times earnings and 0.6 times sales.

For NBTY, the slowdown hit hard in the December 2007 quarter with flat sales and falling margins. That said, the company appears well prepared to weather a slowdown, having cut its debt load from $500 million to $210 million over the last two years. Moody’s recently upgraded its outlook to positive, which is nice for a company with high yield debt in a time of extreme credit market jitters.

The wholesale division has been the company’s strong point, with improving gross margins over the last year. The other half of the business has been poor, requiring store closings in North America. Although European retail performed relatively well in 2007, it was primarily due to currency related issues. In the first quarter, European retail sales declined 4% in local currency.

NBTY is trying to right the retail ship through its store closings and other cost saving moves. The company ended 2007 with 35 fewer stores than it started with. 71 leases are due for renewal in 2008, and the company expects to close 23 more in 2008. NBTY also plans 10 to 12 new store openings this year. In the first quarter, five stores were closed and two opened. These efforts will only be made more difficult if a recession materializes.

I have a few concerns over earnings quality. For example, in each of the last two years the company has reserved less than the actual amount charged for sales returns, bad debt and promotional incentives (an under-reserving trifecta.) However, overall earnings quality measured using the accrual ratio appears strong.

Source: Zacks Research Wizard, compiled by William A. Trent

I’m also nervous about a stock that has had such a big run over the last few weeks. But then again, I had the same concerns about Tupperware (TUP) and it has continued to outperform after rebounding from the same January low. (As a side note, American Oriental Bioengineering (AOB) could represent a catch-up play here.)

The options aren’t generating a particularly good premium right now, so there doesn’t seem much point to a put-write strategy. On the other hand, buying the March $25 puts for $0.15 (as I am writing this) seems like fairly cheap insurance on a long position, given my concerns about the recent run-up.

All in all, though NTY looks fairly cheap so do most retailers and consumer companies. Unless we can get through another quarter without a significant earnings miss or downward revision it just seems too early to call a bottom here.

Disclosures: William Trent has no positions in the stocks mentioned.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Genentech 2Q profit rises 41 percent:

In a pattern now long familiar to investors in one of the world’s largest biotechnology companies, Genentech Inc. again reported a surge in profit, crediting its best-selling cancer drug for its continued hot streak.

Yet the stock is down on the news. As I noted in my earnings preview:

Genentech (DNA – Annual Report), which I own in my personal account, reports on Wednesday. They should beat the $0.71 consensus number, but the cancer treatment approvals aren’t coming as fast and furiously as they used to.

But the story is far from over. The good news: During the quarter, the company began eight Phase III clinical trials. Those studies include Lucentis as a possible treatment for eye problems caused by diabetes and Avastin for a specific form of lung cancer and as a second-line treatment for colon cancer.

Hopefully some of those will set the approval train rolling again.

Disclosure: Author is long Genentech at time of publication.

Mid Cap Watch List (Track at Marketocracy) member American Oriental Bioengineering (AOB), which will also join the Small Cap Watch List (Track at Marketocracy) as of Friday afternoon, has announced it will issue a secondary offering for 8 mln shares:

Pharmaceutical company American Oriental Bioengineering Inc. (AOB.N: Quote, Profile , Research) said in a regulatory filing that it will offer 8 million shares and selling stockholders will sell 500,000 shares.The company expects about $63.8 million in net proceeds from the sale, assuming an offer price of $8.60 per share. It plans to use the proceeds primarily for sales and marketing of products, acquisitions and research and development activities.

True, the company is spending $30 million to acquire a Chinese company. But the company already has $90 million in cash on the balance sheet and no debt. It also has consistently generated enough free cash flow to replenish its account. With the stock down more than a third since the January highs, I am perplexed by the decision to issue shares right now. To me it suggests there is either another very large acquisition in the works, or management is concerned about the future cash flow.

Insiders, by the way, are selling about 7% of the shares being offered, although they will still be significant shareholders.

With the end of the first quarter approaching, it is time to adjust the names in my Watch Lists. I will price all the new lists as of the close on Friday, June 29.

Today I present my planned updates to the Small Cap Watch List. There was a fairly high level of turnover to the list. 12 of the 24 names from the previous run made it to the current list, which was also 24 names. Performance-wise, the list created in March has returned an unweighted average return of 2.6% through June 28, with 80% of the stocks in positive territory. All of the money-losers from the previous list fell out of consideration.
So without further ado, the names on the chopping block from the previous list are: PW Eagle (PWEI), Insteel Industries (IIIN), Allied Defense (ADG - Annual Report), Hartmarx (HMX), Parlux (PARL), Hansen Natural (HANS), FirstFed Financial (FED), Young Innovations (YDNT), ITT Educational (ESI), Rent-a-Center (RCII), Valassis (VCI), and Travelzoo (TZOO). The castaways include four of the five money losers from the previous portfolio (HMX, PARL, YDNT and TZOO) as well as the biggest gainer (ESI).
The new list is:

I will continue to track both lists on StockPickr.

The Economic Calendar looks pretty dull next week, with only Friday’s PPI report likely to get us excited. Look for our usual industry pricing power report.

Looking less dull is the earnings calendar, as earnings season officially begins.

• Research in Motion (RIMM) reports on Tuesday. Consensus is calling for $0.99 EPS on $933 million in sales, and guidance of $1.04 on $994 million for next quarter. We’re taking the under.
• Genentech (DNA - Annual Report also reports on Tuesday. Consensus wants $0.67 EPS on $2.75 billion in sales and guidance of $0.71 on $2.9 billion for next quarter.
• Lam Research (LRCX) reports on Thursday. Consensus expects this quarter and next to bring in about $1.06 on $645 million in sales. We are expecting order flow to disappoint.
• Infosys (INFY) reports on Friday.  Consensus wants $0.40 on $865 million in revenues, and guidance for $0.40 on $920 million. They will make the numbers, but investors will listen closely to the update on visas and employee retention.

William Trent currently owns put options against the shares of Lam Research (LRCX).

With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Large Cap Watch List (Track at Marketocracy).

Though less than the Small Cap Watch List and Mid Cap Watch List (Track at Marketocracy), there was still relatively high turnover in this list. 14 of the original 33 names made the cut for the new list (which was trimmed to just 26 names.) Part of the reason for the turnover was to reduce overlap between the lists. One third of the Mid Cap Watch List (Track at Marketocracy) names appear on each of the Small Cap and Large Cap Watch List (Track at Marketocracy)s, but there is no longer any overlap between small and large.
So without further ado, the names on the chopping block from the previous list are:

3M (MMM); Continental (CTTAY.PK); Mitsui (MITSY); Anheuser-Busch (BUD); ConocoPhillips (COP); Helix Energy (HELX); IndyMac Bancorp (NDE - Annual Report); Barr Pharmaceutical (BRL - Annual Report); Quest Diagnostics (DGX); Public Storage (PSA); ITT Educational Services (ESI); Equifax (EFX); Rent-a-Center (RCII); Kroger (KR); Ricoh (RICOY); First Data Corp. (FDC); Expeditors International (EXPD); and Keyspan (KSE).

The new list is:

Every portfolio is going to have some winners and losers, and the Watch List we created in June, 2006 is no different. The all-cap watch list proved more cumbersome and difficult to measure than we had expected, so we switched to three separate, smaller watch lists that will be updated more regularly, but we still keep track of what is going on in the original list.

On the loser side, the Watch List had more than its share of homebuilders and subprime lenders. However, the overall portfolio has fared well due to an offsetting number of takeovers at premium prices. Beckman Coulter’s (BEC - Annual Report) buyout of Biosite (BSTE) today is an example.

M&A Monday: Beckman Coulter Buys Biosite: Financial News – Yahoo! Finance

Beckman Coulter Inc., which makes biomedical laboratory instruments, said Sunday it will buy diagnostic product maker Biosite Inc. for $1.55 billion.

Beckman Coulter’s offer comes to $85 per share. The price is a 53.5 percent premium on Biosite’s Friday closing price of $55.38 on the New York Stock Exchange. The deal is expected to close in the second quarter of this year.

That’s how we want to see our stocks go out.