Streetwise
Lauren Rudd
Sunday, January 10,
2010
Those Ugly Ducklings Could Be A Swan in Time
In the story of “The Ugly Duckling” by Hans Christian
Andersen, a homely little bird matures into a graceful swan. The story comes to
mind because the two companies discussed this week fail to pass one of two key
intrinsic value tests.
To make matters worse, one of the companies posted negative
earnings for 2009. Yet, these two companies illustrate the point that while
earnings are critical, sometimes it is necessary to dig a little deeper. Perhaps
you are looking at what will become a beautiful swan.
First up is Hologic Corporation (HOLX), a company that I have
talked about in the past because of its acquisition of Cytyc Corporation, a
company also discussed here several times. Hologic is a key provider in nine
areas relating to women's health, including breast cancer diagnosis and
treatment, cervical cancer screening, prenatal testing, and osteoporosis
detection.
For its fiscal year ended September 26, 2009, Hologic
reported revenues of $1.64 billion, a 2.2 percent decrease from the $1.67
billion reported for FY 2008. The decrease was primarily attributable to a
decline in sales of its large digital mammography systems.
The company also reported an earnings loss of $8.48 per
share, as compared to a net loss of $1.57 per share in fiscal 2008. However, the
loss included a write-off of $2.34 billion for the impairment of goodwill
relating to the Cytyc acquisition. Although non-GAAP pro forma numbers are
usually meaningless, in this case it pays to note that if you exclude the
non-cash write-offs, the non-GAAP adjusted net income is $1.17 per share.
The company’s backlog at the close of 2009 was $323.1
million. Furthermore, a 20 percent increase in company’s share price last year
would indicate that investors are not overly concerned about the negative
numbers.
The real difficulty is the intrinsic value of the shares. The
conservative intrinsic value calculation using a free cash flow to the firm
methodology results in an intrinsic value of $39 per share, over double the
recent closing price of $15.01. However, negative earnings invalidate the
discounted earnings approach.
Nonetheless, my earnings forecast for this year, ignoring
non-cash and one-time expenses, is $1.26 per share and $1.38 for 2011. My
12-month target price for the shares is $17.50 for a potential gain of 17
percent.
Next up is Teva Pharmaceutical Industries (TEVA), a company
that has never been discussed here before.
The company develops, produces and sells a range of generic and branded
pharmaceuticals. Its research and development efforts focus on therapies for the
central nervous system (with emphasis on multiple sclerosis), autoimmune
diseases, and oncology.
For its latest quarter ended September 30, 2009, Teva
reported revenues of $3.55 billion, an increase of 25 percent when compared to
2008. Earnings were 72 cents per share as compared to 77 cents in 2008. The
company did point out that it crossed the billion dollar mark in quarterly cash
flow from operations for the first time in its history.
A key factor to Teva’s ongoing success is that it deals
heavily with low cost generic medications. As such the firm is unlikely to be
adversely affected by whatever health care program is enacted. And once again,
investors do not appear to be overly concerned about the small drop in quarterly
earnings, given that the shares have appreciated 33 percent last year.
The intrinsic value of the shares using the free cash flow
model is $116 per share as compared to a recent closing price of $57.20.
However, once again we have difficulty with using the discounted earnings model,
which yields an intrinsic value of $29 per share. The reason is the drop in
income.
Nonetheless, my earnings estimate for 2009 is $3.35 per share
and $4.50 for 2010. My 12-month target price for the shares is $64 per share for
a potential gain of 12.3 percent. There is also an indicated dividend yield of
0.90 percent.
