Hold Off On Hospira
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Hospira (NYSE: HSP) reported 4Q11 results this morning and shares are up more than 6% as the session nears an end. The results were awful thanks to a terrible 2011 that was highlighted by FDA warning letters and plant shutdowns. Actual earnings-per-share for the fourth quarter was -$1.30 due to plant shutdowns and other remediation costs. So what has the shares moving higher? First off, the key plant in Rocky Mount, NC is actually producing again and the stock had been crushed over the last year. Should investors jump on board now, with company operations improving and the stock still down 37% from its 2010 high? I would suggest not, and advise investors to look to other cheap medical device stocks. Waiting on the FDA can be a longer than expected process, and while I think this ship is moving in the right direction; it will be at a much slower pace than most investors anticipate.
Hospira, spun-off from Abbott Laboratories in 2004, is a modestly sized medical device company with annual revenues of $4 billion. They have a 37% share of the generic injectable pharmaceutical market, more than twice that of their nearest competitor. The generic injectable market is more advanced than tablet or pill manufacturing. The process involves much more sterile conditions and temperature controlled environments, hence the recent manufacturing problems. This segment accounts for roughly 65% of total sales. The company’s main competitor in this segment is Baxter International (NYSE: BAX), a larger and more diversified medical device company that has leading positions in injectable therapies, plasma therapies, and evolving generic Biosimilar technologies.
Medical management devices (infusion pumps) account for about 25% of sales and are a stable business with more than 500,000 units in place, mostly at hospitals. The segment is stable, but is seeing increased scrutiny from the FDA, as noted by the lengthy process for the approval of Hospira’s Symbiq pump. The company’s main competitor here is CareFusion (NYSE: CFN) and Baxter. CareFusion, which was spun-off from Cardinal Health in 2009, is the market leader in medical management systems.
Hospira received FDA warning letters in 2010 that got worse in 2011. The main plant in North Carolina that employs over 2,000 individuals and comprises 25% of sales had major violations. The company finally realized the severity of the issue and now appears on top of the situation. Of course that involved a voluntary plant shutdown, $300 million in remediation costs, negative brand impact, and uncertainty over when full production will resume. As it stands now, the plant is operating at 60% capacity and management is hopeful that this will accelerate in the second-half of the year. I contend that this could take longer than expected and should this draw out and become a 2013 issue, then shares will suffer.
Favorable to the company is a dominant position in generic injectables and strong foreign growth opportunities. The company derives about 75% of sales from the United States and has plenty of growth opportunities in other developed G-7 countries by simply taking their existing molecules in the United States and expanding to sales reps in existing foreign footprints. These products, along with the company’s medical management devices, are sold more directly to hospitals and hospital purchasing organizations. That can be good and bad. It creates high switching costs once the products become integrated, but exposes the company to the recent secular downshift in hospital capital spending.
The company is also poised to be a leading generic Biosimilar manufacturer. They have a good position in Europe currently and once the United States finally succumbs, Hospira could easily be the market leader in the United States. Offsetting this favorable attribute is the actual timing of growth could be much longer than many expect. The actual FDA acceptance has to come and then doctors have to get over their initial reluctance to sell Biosimilars. This could take upwards of a decade before the full growth process in underway.
With results skewed by “one-time” operating issues, it can make valuation difficult. Management gave guidance of sales growth for 2012 at -1% to +2% and adjusted EPS of $2.00-$2.30. That equals slow growth and a forward adjusted P/E ratio of 16x at the mid-point. Neither of those is compelling. Return on invested capital was negative in 2011, certainly a one-off event, but the trend has been steadily down since 2004 when it approached 20%. The company has not really grown free cash flow for the last decade. Operating cash flow has generally trended around $550 million and capital expenditures are forecast to fall in the $250 million area. Using these rough gauges yields a FCF yield (operating cash flow less capex divided by enterprise value) of 4.1%, again not that compelling.
Baxter, on the other hand, has Hospira’s favorable attributes without the FDA scrutiny and a much cheaper equity valuation. Baxter is also well positioned in generic Biosimilars and will be competing with Hospira, just as it does now with injectable drugs. The company has the number one position in a very stable plasma based protein business. Baxter’s FCF has leveled off after significant growth in the middle part of the last decade. As it stands now, FCF is about 7x that of Hospira at just under $2 billion and yields a FCF yield of 5.4%. The price-to-earnings multiple is 13x and one of the lowest levels in the last decade for the stock. That is pretty reasonable against stable EPS growth forecasts in the 8-10% range for the coming years. The dividend yield is 2.3% and growing by double-digits annually.
Stay clear of Hospira for now, and don’t buy into the hype that all the issues will be resolved in the first part of 2012. The problems will likely play out into 2013 and that would be a better entry point; when frustrated investors and bullish sell side analyst throw in the towel. The core business is solid and merits consideration, but the timing is not ideal. Investors that like the industry for the coming year should take a hard look at Baxter International.
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