Streetwise

Lauren Rudd

Sunday, February 24, 2013

Seldom Have So Many Said So Little

A deafening diatribe of commentary regarding current economic policy leads me to the conclusion that seldom have so many said so much about a subject about which they know so little. As Charles Darwin wrote, “Ignorance more frequently begets confidence than does knowledge.”

Failure to envision the future objectively is not limited to governments or the media.  A few days before the 1929 market crash, Irving Fisher, a well-known monetary economist, confidently predicted that, "Stock prices have reached what looks like a permanently high plateau." For months after the market crashed, Fisher continued to assure investors that a recovery was just around the corner.

Fisher was blindsided by personal bias. Letting emotions or bias color your investment strategy will be expensive. You need to remain unemotional as you search for investment candidates such as Owens & Minor (OMI), a company never discussed here previously.

OMI is a leading national distributor of medical and surgical supplies, while at the same time offering global third-party logistics services to pharmaceutical, life-science, and medical-device manufacturers through OM HealthCare Logistics and its European business unit, Movianto.

With distribution centers throughout the United States, OMI serves hospitals, integrated healthcare systems, alternate site locations, group purchasing organizations, healthcare manufacturers, and the federal government. OMI also provides technology and consulting programs that improve inventory management and streamline logistics across the entire medical supply chain.

A key question in any corporate analysis is the speed with which cash outflows are converted back into cash inflows? In other words, how fast is cash converted into goods or services and then back into cash? This is also known as the cash conversion cycle or CCC for short.

Why does the CCC matter? The less time it takes a firm to convert outgoing cash into incoming cash, means that less cash is tied up in inventory and accounts receivable, resulting in more cash being available underwrite growth along with increased distributions to shareholders.

To calculate a cash conversion cycle, add days inventory outstanding (DIO) to days sales outstanding (DSO), then subtract days payable outstanding. The lower the number, the more efficient is the operation. The CCC figure for Owens & Minor for the trailing 12 months is 30.6.

The CCC can give you valuable insight into growth sustainability. A longer cash conversion cycle could mean the need to utilize additional financing in order to maintain momentum. For older, mature companies, the CCC can tell you how well the company is managed. Firms that begin to lose control of their CCC may have issues or conflicts with their suppliers and/or customers, a signal of potential future distress.

On a 12-month basis, the trend at Owens & Minor looks good. At 30.6 days, it is 2.0 days better than the five-year average of 32.6 days. The largest contributor to that improvement was DSO, which improved by 1.6 days, as compared to the five-year average. That was partially offset by a 0.3-day increase in DIO. On a quarterly basis, the CCC trend of 28.9 days is little changed from the average of the past eight quarters.

For the year ended December 31, revenue was $8.91 billion, an increase of 3.2 percent when compared to 2011. Net income came in at $1.72 per share, as compared to $1.81 in 2011. In its guidance going forward, OMI is targeting 2013 revenue growth at 2 to 4 percent and net income of $1.90 to $2.00 per share.

The intrinsic value of the shares using a discounted earnings model, with an earnings growth rate of 9.5 percent and a discount rate of 12 percent is $40 per share. The more conservative free cash flow to the firm methodology yields an intrinsic value of $56.73 per share. The shares recently closed at $30.70.