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Summary

  • Cantel’s stock has momentum over the long-term.
  • The company is achieving strong growth in its largest segments.
  • The stock should continue to beat the S&P 500 driven by its above average earnings growth.

Cantel Medical Corporation (NYSE:CMN) is a key player in the healthcare market as a provider of infection and control products/services. The company has been growing at an above average pace, which led the stock to outperform the S&P 500 by a significant margin. The stock is trading below its 52-week high and looks attractive with strong future growth in revenue/earnings. Positive news from the fiscal second quarter 2014 report shows that Cantel Medical has plenty of growth momentum that should continue for at least the next few years.

Segment Analysis

The Endoscopy segment accounted for about 37% of F2Q2014 sales, which amounted to $44.6 million on a 13% year-over-year increase. This increase was encouraging since all of it was derived from organic growth. The company is seeing strength for its endoscope processing equipment. Specifically, sales strength was experienced for the higher margin disinfectant products such as Rapicide PA. Cantel's strong number of installed machines creates an opportunity to expand its service for spare parts, which is experiencing double-digit sales growth.

Cantel has introduced new improved endoscopy disposable products. These products should create some sales momentum in 2014 and into 2015. There is a large opportunity to grow these products internationally. The company has recognized this opportunity and it is making significant investments in sales, marketing, and new product development to increase its penetration in the global market. International endoscopy sales were 20% higher in the first half of fiscal 2014. Cantel is capitalizing on this momentum by stepping up its game internationally. The company is also open to acquisitions in the international endoscopy market, which would create the potential for inorganic growth.

The Water Purification and Filtration segment accounted for 30% of F2Q2014 sales, which increased by 26% to $40.7 million. Organic growth accounted for 18% of sales for the quarter. Growth in this segment resulted from continued demand for water purification equipment, filters, sterilant, and from the hemodialysis water acquisition. This segment achieved an increase of 3% in gross margin due to strong sales of higher margin consumables, higher shipments of equipment, the strength of the acquisition, and from tighter expense control. The increase in gross margin was a good sign considering that there is a higher capital sales percentage in this segment.

Cantel is seeing increased demand for heat-based disinfection systems for central and portable water purification systems and strong orders for new and upgraded dialysis clinics. The automated heat-based systems that Cantel provides are a significant improvement over the old conventional purification systems. Although the prices of the heat-based disinfection systems are higher than the old chemical-based systems, customers benefit from improved performance and overall long-term cost savings with the heat-based systems. Cantel is benefitting from the newer systems as they account for 60% of shipments. I think that the demand for the heat-based systems will continue to increase as more customers realize the benefits and long-term savings associated with them.

The hemodialysis water acquisition is another positive for the Water Purification segment. This business was worth $9 million in revenue in 2012. So, I think that with the solid growth momentum continuing in this segment, the acquisition should be worth over $10 million in annual revenue for Cantel in the near future. Cantel acquired approximately 600 dialysis customers in the United States and Canada as a result of the acquisition. The company can use its expertise to drive the growth of this business and allow it to further strengthen the Water Purification segment. Cantel can market its new products to this new set of customers since they and many others in the U.S. are still using the old chemical-based water filtration systems.

Cantel also has positive growth opportunities for its hollow filter fibers and its REVOX technology sterilization system. The REVOX sterilization system provides room temperature sterilization for advanced medical and drug delivery devices that are sensitive to heat and chemical sterilization methods. The system recently received ISO registration, which will expand its commercial reach. Overall, the Water Purification and Filtration segment has growth momentum, which I think will continue as customers upgrade to the newer technology.

The Healthcare Disposables segment accounted for 21% of F2Q2014 sales. This segment increased modestly by 1.5% to $24.7 million for the quarter, but increased by 15% for the first half of the fiscal year. The weakness in the quarter was attributed to poor weather that led to doctor office closings and cancelled/postponed appointments. Even with that weakness in the quarter, this segment still produced a double-digit gain for the first six months of the fiscal year. This shows that Cantel's third largest segment also contributes significantly to the company's growth.

The company's acquisition of SPS has performed well for this segment. As a result, Cantel is looking to get the SPS Crosstex product lines into the doctor's office and hospital markets. Another bright spot for the Healthcare Disposables segment is the sterility assurance product lines. This includes the SPS products, the ConFirm line of biological indicators, and sterilization pouches, all of which have higher than average margins. Cantel plans to expand this line of products, which should contribute to increased margins.

Cantel also announced the acquisition of Sterilator Company earlier this year. Sterilator is a high quality manufacturer of biological indicators and supplies for sterility assurance. It was also a key supplier to the SPS business. This acquisition provides Cantel with some vertical integration in the Healthcare Disposables segment, which should promote further growth.

The Dialysis segment which accounted for about 6% of F2Q2014 sales declined 13% to $7.6 million. The decline in revenue for this segment resulted from a decrease in demand from Cantel's largest dialysis customer, DaVita Healthcare Partners (NYSE:DVA) and from other companies in the U.S. Cantel's success in this segment depends on dialysis centers that reuse dialyzers. However, this market has been decreasing in the U.S. There has been a shift from reusing dialyzers to single-use dialyzers. The shift resulted from decreased costs of single-use dialyzers and the ease of using a dialyzer one time. Although this segment is shrinking, it does not account for a large chunk of total revenue and the other larger segments more than compensate for it.

Valuation

Since Cantel has grown earnings at an average annual pace of 22% for the past five years and the stock has increased from the single digits to the $30s during this time, I would consider the company a momentum stock. As such, investors are willing to give the stock a premium price for its above average growth. The company is trading at 26 times next year's EPS of $1.27. Although that is a higher forward PE than the S&P 500's ratio of about 16, it is not all that outrageous for a company with high double-digit growth.

Cantel's competitors, Siemens Aktiengesellschaft (SI) and Steris Corp. (NYSE:STE) do have lower forward PE ratios of 13 and 17 respectively. However, the competitors do not have the growth rate that Cantel is experiencing. Siemens and Steris are expected to grow earnings annually at 11% and 10% respectively for the next five years. Cantel is expected to grow earnings annually at 18% for the next five years. Therefore, investors are willing to pay up a bit for Cantel's higher growth. I think that Cantel's stock will continue to outperform these competitors as a result. Cantel's stock has significantly outperformed Siemens and Steris over the past five years and I think that momentum will continue.

The Risks

Cantel derives a significant amount of its revenue from a few large companies. Fresenius Medical Care (NYSE:FMS) and DaVita accounted for about 49% of fiscal 2013 net sales for the Water Purification and Filtration segment. If Cantel lost a significant amount of business from these companies, it could deflate the company's second largest segment.

Cantel faces competition for healthcare disposable products from low cost manufacturers in China, Southeast Asia, etc. The company could lose revenue for this segment as a result of these low cost products. However, Cantel's products are considered good quality, so the company's positive reputation is likely to win out overall for these products.

Conclusion

With the stock trading 14% below its 52-week high, Cantel looks ripe for a rebound. The company is growing its largest segments at double-digit growth rates. Investors are willing to give the stock a price that is a bit higher than the average company. This is justified by Cantel's above average earnings growth. The strong continued growth should drive the stock to outperform the S&P 500 for at least the next few years.

Source: Cantel Medical: Segment Strength Is Driving The Stock