Cantel Medical (CMN) is a manufacturer of infection control equipment. Cantel also generates revenue by selling disinfection chemicals, servicing its equipment, and with monitoring services. I have found Cantel to be an exceptionally well-managed company that has provided consistent revenue and earnings growth that generated strong returns to shareholders all through the recession.
Cantel's latest quarter results, reported September 26, 2013 of the fourth fiscal quarter (Q4) ending July 30, 2013, show that the growth model is working. While Cantel has never given specific guidance, they are on plan for doubling revenue and profits over the next 5 years.
Looking back five years, to the depth of the recession [adjusted for 2 splits, 3 for 2, in the period], on September 25, 2008 CMN ended at $4.39. With a close of $28.97 on September 25, 2013, the five year price increase has been 560%. Obviously no one can promise a 560% return over the next 5 years. In 2008 Cantel was a micro-cap company. Today, with a market cap $1.2 billion, it would still be classified as a small-cap company, pushing towards being a mid-cap. By rule of thumb, a doubling in profits over the next five years should result in an approximate price increase of 100%.
Cantel has grown through organic growth, introducing new products, and by making acquisitions. Having seen some less-than-stellar acquisitions made by other companies (usually because too high of a price was paid), I have been impressed by Cantel's acquisition strategy. Cantel does not pay too much, but once a company or product is acquired, Cantel accelerates the sales of products through its national and increasingly international sales force. Most recently Cantel bought SPSmedical Supply in November, 2012 for its sterility assurance monitoring services, Siemen's American hemodialysis water business in March 2013, and Eagle Pure Water Systems in January 2013.
Cantel spent $2.4 million for research and development in the July quarter. While miniscule by biotechnology standards, it gets a lot of bang for the buck. Cantel has introduced new and improved products in all of its segments, in many cases allowing it to take market share from less innovative competitors.
Cantel Medical has four major business segments:
Endoscopy segment revenue was a record $44.5 million, up 17% y/y. Cantel makes equipment for sterilizing endoscopes (used in colonoscopies, etc.) not the endoscopes themselves. It also makes or supplies the disinfectants used, which were up 18%. There was a 24% increase in spare part revenue y/y. New lines are to be launched in FY 2014, resulting in aggressive growth plans for 2014. However, as this was a record quarter for capital equipment sales, there is no guarantee that Q1 fiscal 2014 will set another record.
Healthcare Disposables (Crosstex and SPS) sales were up 22% y/y. Operating profit in this segment was up 45% y/y on better gross margins and good expense control. While this is a diverse product area, one important products is masks. Long a supplier to dental offices, Cantel is now extending its reach to hospitals and health clinics with its SecureFit masks. These supplies often see spikes during infectious disease scares.
Water Purification and Filtration segment (Mar Cor) revenue was $35.7 million, up 16% y/y. Operating income rose over 60% on cost reductions. Shifting to heat-based systems is helping margins. Orders exceeded shipments, so ended with a record backlog. Siemens dialysis customer adds are nearly complete.
Therapeutic Filtration (formerly Dialysis) segment sales declined 4% y/y. But operating profit up 25%. Asian increases helped offset U.S. declines. This is the lowest margin of Cantel's businesses, and has been de-emphasized for a few years now. However, it could return to growth again as Cantel's business expands internationally.
One of the reasons I invested in Cantel Medical in late 2009 was my better understanding of the risk of infections in hospitals and dental offices, including from deadly antibiotic-resistant bacteria and emerging viruses. Companies creating new antibiotics and vaccines can be a great investment, but keeping patients safe from exposure in medical settings is a far more effective strategy for the health economy. Cantel Medical is not the only company in this field, but it is the only pure play of any size.
I now put a high value on Cantel Medical's management team. There may be the occasional bad quarter, and not every acquisition may work as well as the last half-dozen that I have tracked, but management's track record on handling both opportunities and difficulties is as good as any I have followed.
How much should you be willing to pay for HNSN, given its recent results, track record, and future plans?
Net income and EPS (both GAAP) growth did not fare as well in Q4 as revenue growth. Is that a warning?
Net income was $10.2 million, up 5% from $9.7 million year-earlier. EPS (earnings per share) were $0.25, up 4% from $0.24 year-earlier.
There were three headwinds for earnings and EPS. Starting in January 2013 the new medical devices tax kicked in, which knocked off about $0.02 per share. In addition, there was a $0.02 one-time tax benefit in Q4 2012. Adjusting for those effects, EPS was up 25% y/y.
As usual, a healthy growth rate should result in a P/E above 20. Trailing 12 month P/E is 31.6 after today's price change up $1.65 or 5.7% to $30.62.
The P/E ratio is reasonable, if not a bargain, given growth rates. As with all growth stocks with P/Es higher than the market average, a flattening of revenue and profits would probably result in a lower P/E and stock price, even at today's level of profitability. It is a well-understood risk.
Cash flow from operations in the quarter was $17.0 million. Capital expense was $2.7 million in the quarter. The cash and equivalents balance was built up to $34.1 million, up $3.4 million in the quarter. The rest of the cash went to debt service. Debt ended at $95.0 million. All of the debt is from acquisitions, and for the last five years management has gone through cycles of paying down acquisition-related debt. Interest expense was $0.7 million. Again, this illustrates why I like Cantel's management. Instead of just running up debts, and consequent interest payments, they navigate a course that keeps them in top form for when they want to make new acquisitions.
Using cash flow from operations less capital expenditures, the debt would be entirely repaid in under two years. However, I expect more acquisitions to be made (the timing is uncertain). Smaller acquisitions could be made with cash, but larger ones would require more borrowing.
Cantel pays a dividend, but it does not amount to much, just $0.074 per year, paid semi-annually. I like dividends, but in this case I am happy with CMN building shareholder value through sales growth and acquisitions.
One last short-term caveat. Cantel plans to hire 30 more sales and marketing people, plus two additional senior executives. Those expenses will likely appear in fiscal Q1 (the current quarter) but not bring obvious results until calendar 2014. I see them as a necessary investment, given Cantel is rapidly growing revenues. About half of the new hires will be in Asia.
Given all this, I think the current share price is fair. You won't be overpaying if you are a long-term investor even thought the stock is at an all-time high. You will be buying a company that is going to grow profits, just as it has in the past. I believe CMN can indeed double profits over the next five years, which is highly likely to beat the market indexes.