When a company exponentially grows like Mesa Laboratories (MLAB) has done in the last few years, I am sure it turns a couple heads. The company has put together a growth strategy based upon acquisition and organic growth. It appears to be working well for the company. Let's explore its growth strategy, how it works, the results of its implementation and what we can extrapolate in the future for the company.
What Is Mesa Laboratories?
Mesa Laboratories has been a viable business since it opened its doors in 1982, headquartered in Colorado. Presently it is organized into two separate divisions with three physical locations. There is the Instrument Division and a Biological Indicator Division. Both manufacture state of the art measuring products and provide ongoing top flight service to support its products. These are also its two sources of revenue.
Let's take a look at the two divisions.
This division manufactures and markets quality control instruments and disposable products utilized in the following industries: healthcare, pharmaceutical, food and beverage, medical device, and petrochemical industries. The products are purchased and used by customers for testing, quality control, safety validation and regulatory compliance. As an example, disposable medical meters for the diabetic market have been in demand. Hand held meters for highly accurate measurements for diabetic patients are needed for daily use. This is presently its biggest selling disposable.
Biological Indicator Division
This division manufactures and markets Biological Indicators (BI) and distributes Chemical Indicators ((CI)) used to access the effectiveness of the sterilization process which includes steam, gas, hydrogen peroxide, and radiation in the hospital, dental, medical device and pharmaceutical industries. Strength of the company in this division is market stability. The Biological indicator division is not prone to the ups and downs of the capital market like the instrument division may be. Since it is a highly regulated market, clients buy the "indicators" regardless of the economy. It's non discretionary and very stable, even during the recession in 2009 sales were stable and even grew.
How Are Products Sold?
Sales are generated through direct sales, marketing staff, and distributors. There are 180 distributors in Europe, Africa, Asia, South America, Australia, Canada and Mexico. The Instrument Division offers products intent to contain costs, improve the quality of their products and services, and help them meet their regulatory requirements. The Biological Division provides test products designed to minimize incubation and test result time.
In the healthcare fields, I would be concerned about a small company coming up against some of the larger more established companies. Competitors are larger global names like Covidien plc (COV), Baxter International (BAX) and Thermo Fisher Scientific (TMO). These companies are more established, have a larger budget and a better presence in many markets. So here I am as a small investor looking at Mesa Labs. Why would I invest in them? How can they compete against the larger more established medical supply companies? These are valid questions and obviously the company has been doing something right as we look at its present growth.
Unique Marketing Approach
Obviously this would catch my attention and I want to know how the company can be successful like it is. Mesa Labs has a unique marketing approach that keeps competition at minimal levels. It tends to focus on markets and product lines where it can have a dominant market share. It tries to stay out of markets with dozens of companies vying for sales and market share. The products the company sells are on the high end of performance and price, so it looks to stay in these small high end markets.
An example would be the company's data loggers. They are used by companies that need high temperature and highly accurate measurements. There are only a few companies that compete in this arena. The general shipping industry would not use its data loggers, they are too expensive. Specialty fields that are highly regulated like pharmaceutical, food and beverage, and medical devices are interested in its products. In the regulatory market, Mesa is the industry leader in quality control instruments. Four years ago, they were the first to come up with high end data communicated via radio. Since then a few other competitors have followed, but MLAB continues to lead the way.
This unique approach opens highly specialized markets for Mesa labs and allows it to dominate the markets, staying away from larger global competition in the vast general medical supply markets. It has been working.
Mesa Laboratories has been following the same growth strategy for the last couple years and I see no reason why it would change with the success it has had. There goal has been to grow revenue and profits by double digits on a yearly basis through organic growth and strategic acquisition. Through organic growth, the company has focused on improving distribution channels to reach customers more efficiently and pursue new product development increasing product portfolio.
Is this growth strategy working?
How did the Instruments division grow the last two years?
The Instrument product division grew by 11% in 2011 (primarily due to the addition of the Torqo line in December of 2009). Organic sales were basically flat across the board. I mentioned earlier in this article that this division was more susceptible to economic conditions than the regulated Biological Indicator division and with the slow global economy, sales figures show no organic growth in 2011, but 2012 is a different story. Growth in this division was 9% and two factors entered into the success. First, organic sales grew with the addition of distributors. The company added $1.62 million in gross profit while fixed costs remained flat. The second catalyst for growth was a good organizational move by management. The acquisition of the Torqo product line took a slight cut off margins, but the company integrated manufacturing of these products into the Lakewood, Colorado, facility which saved costs and contributed an extra $500,000 in gross profit to the company. This is one of the reasons for the 2% increase in gross margin from 2011 to 2012. In this division, growth over the last two years have taken place through acquisition, organic sales through increased distributorship, and manufacturing integration on the skilled decisions of management.
How did the Biological Indicator division grow the last two years?
Since this division is less susceptible to economic swings, unlike the Instruments division, I would expect steady growth from a plan that is working. 2011 saw a huge increase as this division grew sales by 130% ($16.45 million) from $7.14 million in 2010. The reason for the growth is the acquisition of SGM Biotech in April of 2010 and Apex Laboratory products in December of 2010. The acquisitions had a minor affect upon gross margins and Apex was slightly positive. Organically the division grew at 10%. The acquisitions were forecasted to have a positive impact upon margins after numbers were inserted into a whole year's performance. It appears this was true. The 2% increase in margins from 2011 to 2012 is just what was expected. So the acquisitions worked to the company's advantage and organic growth also continues to grow, not only did it increase by 10% in 2011, but it accrued an additional $2.3 million over 2011 organic numbers.
It Looks like Its Growth Strategy is Working
It appears that management has a good track record when it comes to initiating growth in the double digit range through acquisitions and organic growth. Acquisitions: Torqo products; Apex products; and Biotech products have been integrated into the company successfully. Revenue, gross profits, net income, and diluted EPS have all increased substantially the last two years while gross margins continue to rise. It is not back to the levels before the acquisitions, but it is moving in the right direction. Organic growth was challenging for the Instrumental division because of the weaker global economy but acquisitions carried the load. The more reliable Biological Indicator division saw double digit organic growth along side substantial acquisition growth.
Growth and Sales Expense Increases
Margins in sales will vary from year to year depending on what is being sold. Most of its products have gross margins of 50% +, but depending on what is being sold, margins will change. Mesa's dialysis products are sold with a few companies that have large chain treatment centers. Renal market products are more price sensitive than data logger products. Biological indicator products have lower margins than Instrumentation products. Therefore, from one year to the next, the move toward Instrumentation products as a majority of sales will produce lower sales expenses and higher gross margins. Then-visa versa for Biological Indicator products.
Keeping this in mind, I am impressed with Mesa's track record and management's ability to keep a handle on sales costs. Mesa has performed well when it comes to "cost of sales." As a percentage of sales, selling costs in 2011, 2010 and 2009 where: 11.2%, 11.9% and 14.2%, respectively. The decline in percentage can be attributed to increases in sales while increased costs were minimal. Cost savings initiatives, started in 2010, showed the largest decrease in 2010 and then carried over into 2011. As a percentage of sales, costs have remained flat also in 2012. This is a reflection upon management's ability to increase sales but keep the "cost of doing business" at a controllable level. If they have this track record through the growth strategy the last few years, I would expect the company may be able to continue this into the future.
Why Invest in Mesa Laboratories?
I have explored MLAB's growth strategy and I believe it has proven it is working well. The last three acquisitions have been integrated into the company's system and it has increased revenue, gross profits and net income. Even better, both gross margins and net profit margins have increased. Organic growth through the addition of distributors has been strong and constant in the Biological Indicator division while the Instrumental division has held its own in the lagging global economy. As the global economy increases, the Instrumental division should find organic sales go from flat to sizable growth. The Biological Indicator division, being more stable, provides a solid anchor to continue to grow like it has in the past.
Using an EPS and P/E Ratio system, I believe the stock is overvalued right now. It may be a victim of its own success. I calculated a fair value price of 34.71 while the stock presently trades at 52.21. Although it appears over priced, I would not disregard investing in the company. An investment strategy for a value investor may not make sense. A growth investor, on the other hand, may like this stock. I believe its strategy will help earnings grow at an above-average rate compared to the market as a whole. It has proven it can so far.
I have projected earnings and price growth for the stock over the next four years and I see an increase in the value of the EPS growing in proportion to the value of the stock by 22.7% from where it is today. These projections are based upon past performance before and after the last three acquisitions, so it is well balanced. This is the most promising reason to invest in the stock at this point. Price growth, if steady, I do not see as that great, I projected an 18% growth based upon future P/E and earnings growth. If one were interested in investing in Mesa Laboratories, I would suggest it be for earnings growth. I believe the stock is presently over valued and I have not projected a lot of price growth in the next few years.