Pair Trades: Bard and Intuitive Surgical

This is the 4th in a series of articles that attempt to identify relative value discrepancies between two closely related securities. So far, the first three have been modestly successful in aggregate, though it's a little early to be drawing conclusions:

• 3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)
• 4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)
• 5/3: Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)

I will eventually do a review of each of these, but the first one is slightly negative now (after a great start) while the other two are equally positive.

As many of you are aware, I love Intuitive Surgical (ISRG) as a company. But as I warned when I was very bullish on the name back in March, "I have always believed that one shouldn't fall in love with stocks." I reported back after their disappointing Q1 results that the stock still had room to run, highlighting 175 by year-end as a potential target in an optimistic case. Well, 8% upside over the next 8 months doesn't seem worth the risk. I actually sold the last piece in my Top 20 Model Portfolio last week to buy C.R. Bard (BCR). We have been very fortunate in the model, with a return in 2009 so far of almost 28%, and I want to protect those returns!

Big picture, both of these companies are excellent Healthcare companies with similar market caps. The whole idea here is to move out of the high PE (high expected growth) story into a more conservative and safer stock. This rationale is quite similar to the JNJ/AGN trade. Here is how it looks (click to enlarge):

Again, ISRG has a great balance sheet (as does BCR). The key metrics here are the ones I boxed: The PE is very high for ISRG relative to BCR, and the FCF yield doesn't give any room for disappointment. In contrasting the two, it is important to consider that BCR derives essentially all of its sales from consumables, while ISRG relies upon $1.4mm (or higher now with the new product) capital equipment sales for about 1/2 of its revenue. If you share my view that the economy will remain weak for quite some time, this isn't the time to be aggressive in growth assumptions. I want to own ISRG again, but not at this price.

Disclosure: Long BCR

Comments

[Alan Brochs...:]

Cetin, I sure admire the commitment you make to your constant pimping of your blog with your monothematic comments (soon you will be up to 2000 - way to go). It would be nice, however, if you were to keep it relevant. This article isn't saying to buy ISRG, so your suggestion that POT and MOS are better isn't topical at all. You could have at least said "BCR is a good stock, etc." By the way, when you say that "anything in March" made money, BCR, in fact, is up only very marginally. Maybe that's the point I am trying to make.

When people are building portfolios, they shouldn't force every single position to conform to a single theme (like you seem to suggest), or they risk being improperly diversified. Surely you are 100% right, so that's not a problem, but what if your not? A properly diversified portfolio, in my opinion, should have representation from several different economic sectors at a minimum (not just Tech and ag-related). One could argue that it should have exposure to companies of differing market caps too, but that's another issue. It would make little sense to build a portfolio solely of the stocks that you constantly seem to mention on other people's articles. Sure, have some high exposure, but never make it an all or nothing proposition in my opinion.

May 10 07:04 AM

[Alan Brochs...:]

Definition of "more open minded": Fervent belief that there is only one type of stock to own and it can only go up

May 10 03:49 PM

[BigOlDave:]

Alan: You are one of my favorites. And I agree that Cetin has never had a thought I’d consider worth sharing.

I own 200 shares of Bard (BCR). Seeing it compared with ISRG was interesting, but it would seem that – except for the fact that both sell to hospitals – they are very different companies.

In terms of metrics, what appealed to me about BCR compared to all other investments out there (I passed over MOS and POT recently in favor of BCR) is its low beta (0.36), high gross margins (62%), low P/E (17), solid growth (9.5% CAGR, with 14% expected in the future, certainly less flashy than ISRG), a stunningly high S&P IQ (223/250) and very low debt/equity (0.08, though it is hard to beat zero).

I felt I needed Healthcare exposure (Bard is in patient care devises & supplies) to give my portfolio balance in a sector expected to perform well in a recessionary economy. BCR showed up on screens using metrics like the above that are important to me.

Other analysts also like BCR. S&P gives it 5 stars (Strong Buy); Reuters rates it “Outperform”; and FirstCall has it “Buy”. ValueLine has it top rated for Timeliness and Safety. Among the shareholder masses, The Motley Fool community gives both 4 stars (out of 5).

Recently BCR shares are seeing relatively heavy institutional accumulation. Compare the charts of ISRG and BCR and you also find that BCR is the Steady Eddie of the pair.

Thanks again, Alan, for your interesting analyses.

Dave

May 10 05:41 PM

[Alan Brochs...:]

Thanks for your comment, Dave. You are thinking like a real person instead of an institution - of course they are very different. Joe Money Manager, who is measured against the S&P 500 and who wants to own Healthcare to within 2% of its representation of the index, must choose between BCR or ISRG (both in the index). It's kind of sad, isn't it?

My first pair (MPR and NLC) were remotely related but entirely different market caps. My second pair (AGN and JNJ) have some overlap and are both large-cap, though JNJ is actually Mega-cap. My third pair (COLM and UA) are competitors but not really (I bet COLM wouldn't want me to dis their brand, but I don't think it has nearly the cache). This one (BCR and ISRG) is actually a bit closer than you might think. They both sell into hospitals and have some overlap on their key areas (urology, certainly). No, they aren't really competitors at all though. BCR, as you say, is steady eddie and, to me, not real exciting. Exciting, though, is very risky in this type of environment. I would expect ISRG to do better over the next 5 years, but not the next 5 months (absent a shot from deep in 3pt territory landing).

May 10 06:19 PM

[speculari:]

Alan,
Interesting stuff. BCR is certainly a fine company, generally good metrics - I would voice a concern on the content of fund ownership (now at about 37%) , I prefer the range of 15%-30%. Also, have a preference for zero debt. I don't know why POT or MOS should even enter into this discussion - totally different arena. I do not think that buy & hold is a particlarly good strategy, nor is so-called diversification. What about raising cash during certain periods? I concur with the aspect of never falling in love with any company or it's ticker symbol. One must recognize, however, that ISRG is markedly different from BCR - zero debt, twice the inventory t/o ratio, 4.5x the earnings growth potential, a very powerful product offering, strong patents, and recurring revenue, etc.

May 11 09:06 AM

[BigOlDave:]

Regarding Jim Cramer, everybody loves to beat him up. He basks in the negative publicity. Meaning, Cramer is a colorful showman, but not a very useful investment advisor. The Motley Fool ranks Cramer 85th of 177 Wall Street stock pickers …with 45.7% accuracy (128th of 177).

So Jim Cramer has demonstrably below-average for someone who makes long recommendations for a living. In fairness to Cramer, he has 1,633 active picks to his name, 3X the next highest Wall Streeter, suggesting that nobody maintains a running inquiry with him that he would no longer own some of the stocks.

I’ve just signed up at your website ( www.investbymodel.com/ ) and will see how you stack up. Your “Top 20” portfolio is absolutely scalding the S&P 500 by over 23 percentage points. I expect that you will continue to beat the Wall Street crowd by a handsome margin. The Conservative Growth / Balanced portfolio might also be of interest. I’ve subscribed to an AB Analytical Services trial for DIY investors.

You run interesting screens for potential out performers or losers, then grind down into the fundamentals and key drivers. I like that about your SA posts. You’d bring an interesting freshness to a talking-head TV show based on investment screening and a pick or two, along with your thesis for it. This would be a combination of technical analysis, granular fundamentals and horse sense.

I bet you would be a bigger star than Cramer.

But you’d be subjected to even more critics like Cretin.

Dave

May 11 12:22 PM

[Alan Brochs...:]

Great points - note that BCR has net cash. Also, we are talking high-end toyota vs lexus, not ford pinto to rolls royce


On May 11 09:06 AM speculari wrote:

> Alan,
> Interesting stuff. BCR is certainly a fine company, generally good
> metrics - I would voice a concern on the content of fund ownership
> (now at about 37%) , I prefer the range of 15%-30%. Also, have a
> preference for zero debt. I don't know why POT or MOS should even
> enter into this discussion - totally different arena. I do not think
> that buy & hold is a particlarly good strategy, nor is so-called
> diversification. What about raising cash during certain periods?
> I concur with the aspect of never falling in love with any company
> or it's ticker symbol. One must recognize, however, that ISRG is
> markedly different from BCR - zero debt, twice the inventory t/o
> ratio, 4.5x the earnings growth potential, a very powerful product
> offering, strong patents, and recurring revenue, etc.

May 11 03:38 PM

[Alan Brochs...:]

You are too kind. I actually recognized your email address when I saw the sign-up...


On May 11 12:22 PM BigOlDave wrote:

> Regarding Jim Cramer, everybody loves to beat him up. He basks in
> the negative publicity. Meaning, Cramer is a colorful showman, but
> not a very useful investment advisor. The Motley Fool ranks Cramer
> 85th of 177 Wall Street stock pickers …with 45.7% accuracy (128th
> of 177).
>
> So Jim Cramer has demonstrably below-average for someone who makes
> long recommendations for a living. In fairness to Cramer, he has
> 1,633 active picks to his name, 3X the next highest Wall Streeter,
> suggesting that nobody maintains a running inquiry with him that
> he would no longer own some of the stocks.
>
> I’ve just signed up at your website ( www.investbymodel.com//
> ) and will see how you stack up. Your “Top 20” portfolio is absolutely
> scalding the S&P 500 by over 23 percentage points. I expect that
> you will continue to beat the Wall Street crowd by a handsome margin.
> The Conservative Growth / Balanced portfolio might also be of interest.
> I’ve subscribed to an AB Analytical Services trial for DIY investors.
>
>
> You run interesting screens for potential out performers or losers,
> then grind down into the fundamentals and key drivers. I like that
> about your SA posts. You’d bring an interesting freshness to a talking-head
> TV show based on investment screening and a pick or two, along with
> your thesis for it. This would be a combination of technical analysis,
> granular fundamentals and horse sense.
>
> I bet you would be a bigger star than Cramer.
>
> But you’d be subjected to even more critics like Cretin.
>
> Dave
>
>

May 11 03:42 PM

[speculari:]

Alan,
I don't think the "automobile" analogy is pertinent here. If it were, BCR would not be anything more than an OEM supplier of, let's say, "braking" systems - but, certainly not a complete car. They make a wide array of fine products(from catheters to stents to sump tubes to shunts, etc.) In point of fact, why not put them with other companies a little bit more in line ; such as, THOR, OFIX, ICUI, or AMMD?


On May 11 03:38 PM Alan Brochstein wrote:

> Great points - note that BCR has net cash. Also, we are talking high-end
> toyota vs lexus, not ford pinto to rolls royce

May 20 01:08 PM