David Blood and Al Gore’s Hedge Fund Owns 5.1% of This Medical Equipment Stock

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David Blood, the former head of Goldman Sachs Asset Management, and former Vice President Al Gore co-founded Generation Investment Management in 2004. The fund recently filed a 13G with the SEC to disclose ownership of 4.4 million shares of Henry Schein (NASDAQ: HSIC), an $8.9 billion market cap medical equipment company, or 5.1% of the total shares outstanding.

At Insider Monkey, we track quarterly 13F filings from hundreds of hedge funds, including Generation, as part of our work researching investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year) and can see from our database that Generation had owned 4.2 million shares of Henry Schein at the end of March. Check out Generation's stock picks.

At that time, the stock was its largest holding by market value, so, while only a small number of shares have been bought since that time, it’s interesting that Generation would add to its largest position.

Taking a closer look at the company

In the first quarter of 2013, Henry Schein’s revenue grew 9% versus a year earlier. The animal health business, which accounted for 28% of total sales, was the fastest-growing of the company’s segments and helped make up for only 3% growth in the dental division (the largest of Henry Schein’s segments, at just over half of revenue). With expenses rising as well, however, there was little change in the company’s pre-tax income after adding back some restructuring charges to the Q1 2012 numbers.

The financial community, however, is quite bullish on Henry Schein: at its current valuation, the stock trades at 22 times trailing earnings. Even if the company was holding its margins steady, and therefore growing net income at the same rate as revenue, it would be difficult to call it undervalued at that price; given the fact that costs seem to be outpacing sales to the point that pretax profits have been rising only modestly, the stock does not look like a good value.

Wall Street analysts expect little earnings growth at least in the near-term, with their forecasts implying a forward P/E of 19. In addition to Generation’s involvement, billionaire Ken Fisher’s Fisher Asset Management reported a position of 590,000 shares in its own 13F (find Fisher's favorite stocks).

Comparing Henry Schein to its peers

Other companies which sell and distribute medical equipment include Patterson Companies, Owens & Minor (NYSE: OMI), MWI Veterinary Supply, and McKesson (NYSE: MCK). This peer group is characterized by high earnings multiples as the market looks for high growth.

MWI Veterinary is valued at 28 times trailing earnings, though it did report double-digit growth rates on both top and bottom lines in its most recent quarter compared to the same period in the previous year. It was also noted in our look at Henry Schein that its animal health unit was a strong point, so MWI does merit something of a premium to these other companies in our view.

The other three listed peers carry trailing P/Es in the 20-21 range, roughly in line with where Henry Schein trades. McKesson experienced a steep decline in its earnings in fiscal Q4 (which ended in March) from levels a year earlier, but the sell-side apparently expects the company to recover and as a result, it’s priced at only 13 times forward earnings estimates. Considering that the company’s revenue had been down as well, investors should probably be skeptical of analysts' optimism here.

Patterson has reported less than 5% change on either revenue or net income from its levels a year ago, and while that’s better than a declining business, the current valuation seems to be quite high given recent performance. Owens & Minor is a popular short target, with 14% of the float held short. With its earnings declining as well, and with revenue growth being weak, investors shouldn’t count on it growing fast enough in the future to justify its current valuation.

Conclusion

The industry as a whole seems to be pricing in quite aggressive growth compared to recent results. McKesson is the only company here which could qualify as a value, and even then, it would be because of optimistic analyst projections; with the business struggling recently, it should probably be avoided. MWI has been growing nicely, and might be worth looking into if it can continue that trend for another quarter or so, but at this point, its earnings multiple would recommend against buying as well. 

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends McKesson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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