(This is the first in a 3-part series of articles dealing with small cap companies that are well positioned to survive the fundamental changes that have impacted the primary drivers of growth in the recently ended business cycle.)
The stock market, being true to form, served as a reliable leading indicator when it peaked in October 2007 to signal a recession. It took NBER (National Bureau of Economic Research) over a year to reach a similar conclusion when it reported that the economy had peaked in December 2007. Small businesses, i.e. companies employing fewer than 500 employees, are certainly sharing the pain as they represent 99.7% of all employer firms. However, it is small cap stocks that historically tend to outperform the stock market, our ever-so-reliable leading indicator, whenever it decides to inform that a recession has ended.
Now, every business economic cycle is driven by its own set of catalysts. The demographic force of baby boomers, over-expansion of credit, demand for productivity-enhancing technology, and lower tax rates drove this one. No one knows for certain which themes will drive the next cycle, but examining the market’s reaction to the demise of these above catalysts may provide clues and help rehabilitate portfolios until then. This first in a series of articles will focus on an individual small cap company that is uniquely positioned to capitalize on the demographic forces that continue to evolve and drive the U.S. economy.
Regardless of market conditions and the credit crisis, the financial media barely mentions that as more baby boomers move along the time line, the outlay of cash flow used to managed their lives will be increasingly redirected towards health maintenance and treatment services. It is only logical that responsible reallocation of assets occurs. However, Wall Street and its greed may have beaten Main Street to the punch on this one. Even without the financial crisis, this demographic fact alone is enough to trigger a seismic shift from growth and riskier assets such as equities into more conservative income-producing assets.
Life goes on and as time changes, the needs and priorities of the people who exist in it also change. Another demographic fact is that as people grow older, they involuntarily join a majority which represents the core base of hospital and health care patient populations.
Besides this, the various phases of the economic business cycle (i.e. expansion, peak, recession, and trough) have no influence on the quantity of physical illness. Because of this, one company that is relatively immune to periods of economic malaise and to contracting any of the symptoms infecting most corporate balance sheets is Meridian Bioscience (VIVO).
Meridian Bioscience (Ticker: VIVO; Industry: Medical Products; Market Cap: $952mm; Avg Volume: 381k) is a life sciences company that produces, markets and distributes diagnostic test kits that are used in early detection of viral, gastrointestinal, and respiratory infections. Their competitive edge is the simplicity of use and speedy results of its core products which are a viable alternative to more time consuming and costlier traditional blood work. Instead, hospitals can use nasal, throat or stool swabs.
In terms of financial stability, this is not your father’s small cap. The company is very solid. In a tight credit environment, it is in the enviable position of having zero debt combined with strong cash flow growth. Its current cash flow per share is $0.86 vs. $0.72 (2007) and $0.52 (5 year average). With an estimated 19.82% earnings growth for the current year and average 21% earnings growth projected over the next 3 -5 years, the company should be able to maintain its steady increase of cash flow and organically grow its business.
Revenue sources are also stable. Over 80% of its sales are derived from diagnostic testing for infectious diseases and is represented by a customer base that includes acute-care hospitals, outpatient clinics and large laboratory outfits, e.g. Quest Diagnostics and Laboratory Corp. of America (DGX). Because so many infections are contracted from hospitals, the federal government has threatened to penalize those with high infection rates, thus creating an added incentive for its core customers to continue using its products. Its larger life sciences customers are Abbott Laboratories (ABT) and Siemens (SI), two blue chip large caps healthy enough to survive the recession. Rounding out its customer base is the National Institute of Health which awarded Meridian’s life science unit a contract worth $12.2mm in exchange for producing up to 10 experimental vaccines per year from newly discovered molecules.
Even more promising are its future growth prospects and opportunities. In late November 2008, the FDA approved two of its flu viral tests: TRU FLU and TRU RSV. CEO John Kraeutler stated, "the production of vaccines and injectable drugs is a small specialty area of our business," and indicated that Meridian is scaling up drugs for biotech firms. In the areas of molecular testing, it is developing a new molecular diagnostic test technology licensed from Eiken Chemical in Japan that would be used to target and measure DNA or RNA. CEO Kraeutler regards this technology as a strategic driver for future organic growth. If this is not enough, it also has plans to grow its existing international revenue from 33% to 50% of total sales over the next three years in Europe, Japan, and China.
On a valuation basis, the stock is cheap. Although valuation metrics have contracted in the current market environment, it is mainly due to downward revisions of earnings by analysts. This is simply not the case with Meridian as its growth prospects remain solid and the nature of its business is not severely impacted by the recession. It current P/E is 33 while its Forward P/E is 22.5. On a historical basis, it trades at a 23% discount to its 5 year average P/E. Investors also get growth at a reasonable price as the PEG (Price-to-Earnings Growth ratio) is only 1.27.
Technically, as of the writing of this report (12-10-2008), its stock is trading in a consolidation pattern and attempting to build support near its 50 day moving average. The short-term/daily trend is up; the intermediate/weekly trend is lateral; and the long-term/primary trend is down. Intermediate support levels are at 22.50 and 21.65 while resistance levels are 26.30 and 27.50. Year-to-date the stock is down -21.48% but on a relative basis, it has outperformed the S&P 500 by 28.33% during the same period.
In summary, Meridian Bioscience is well positioned to maximize value for its shareholders as it focuses on the aging populations within the U.S., Europe, Japan, and China. Its strong balance sheet should afford it the flexibility to pursue and adapt to market opportunities as they arise in an industry that is relatively immune from the subprime virus affecting the global economy. Last, its relative strength more or less confirms the above, despite the tsunami-like deleveraging from risky assets that has wiped out just about any form of wealth that stands in its path. Immunize your portfolio with this one and remain Hillbent for phase 2’s followup…