Streetwise

Lauren Rudd

Sunday, January 8, 2012

Are They Really Ugly Ducklings

In “The Ugly Duckling” by Hans Christian Andersen, a homely little bird matures into a graceful swan. The story comes to mind once again because of two companies that were “ugly ducklings” for the past two years. The question is will they soon spread their wings as graceful swans? See what you think.

First up is Hologic Corporation (HOLX), a key provider within the women's health arena. For its fiscal year ended September 24, 2011, Hologic’s revenues totaled $1.79 billion, an increase of 6.5 percent over the year before. This increase represented organic revenue growth in all four of the Company's operating divisions.

As Hologic points out, more women are having their wellness exams, yet surgical and other more discretionary procedures are clearly feeling the brunt of the weak economy and persistent unemployment.

Furthermore, approximately 50 percent of the company’s international business comes from Europe where many Eurozone countries are struggling financially. While this could potentially impact the Company’s international growth going forward, strong growth potential continues in Asia, China and Latin America.

Exempting one-time and non-cash charges, the Company's non-GAAP net income increased 8.4 percent to $1.26 per share in fiscal 2011, as compared to $1.18 the previous year.

In its guidance for the year, Hologic forecasts revenues of between $1.9 billion and $1.925 billion, an expected increase of 6 to 8 percent over fiscal 2011. Non-GAAP earnings are projected at between $1.35 and $1.37 per share.

A year ago my 2011 earnings estimate (non-GAAP) was $1.28 per share with a 12-month target price on the shares of $22, as compared to a price back then of $19.08. The shares recently closed at $17.91. Although earnings and share price appreciation were a bit light when compared to my estimates, the potential is there for the company to become a beautiful swan.

Looking at the intrinsic value of the shares, the conservative free cash flow to the firm methodology generates an intrinsic value of $39 per share, nearly double the recent closing price. However, the discounted earnings approach produces an intrinsic value of only about $15 per share, due in part to the amount of long-term debt. Here is an instance where I put considerably more trust in the free cash flow model.

Meanwhile, I am raising my non-GAAP earnings forecast for 2012 to $1.34 per share and keeping my 12-month target price for the shares at $22 for a potential capital gain of 23 percent.

Next up is an old friend but again a bit of an ugly duckling, Teva Pharmaceutical (TEVA), a company that develops, produces and sells a range of generic and branded pharmaceuticals.

A key to Teva’s ongoing success is that it deals heavily with low cost generic medications. As Barron’s recently pointed out, Teva dominates a $93 billion generic-drug industry that could almost double in size by 2015.

For its third quarter ended September 30, Teva reported net sales of $4.34 billion, as compared with $4.25 billion for the same period a year ago. Non-GAAP earnings were $1.25 per share as compared to $1.30 a year ago.

The decline was attributed to a lack of new generic drug launches in the United States. However, the company expects to report a strong fourth quarter including an improved U.S. generics business, led by the exclusive launch of generic Zyprexa.

Teva’s guidance for the upcoming year shows net sales of approximately $22 billion and non-GAAP income of between $5.48 and $5.68 per share. The Company is also projecting cash flow from operations of $5 billion, while free cash flow (cash flow from operations minus capital expenditures and dividends) of is expected to be approximately $3 billion.

The intrinsic value of the shares using a discounted earnings model produces an intrinsic value of $112 per share, while the free cash flow to the firm model yields a result of $156 per share. The shares recently closed at $43.10. Once again we have a beautiful swan in the making.