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Summary

  • Hologic's Q2 results beat expectations and guidance has been upped for the year. The company is on its way toward a resumption of growth and improved metrics.
  • They generate significant cash flow enabling debt reduction and share buybacks. At less than 7 times EBITDA, the equity is too cheap. We'd expect a buyout if share price lags.
  • Significant upside exists from a resumption of revenue growth, improved margins, and multiple expansion. We have a $27 near-term target and shares could easily double by 2017.

Hologic, Inc. (NASDAQ:HOLX) is in the business of developing medical diagnostic products, imaging systems and surgical products, with an emphasis on serving the healthcare needs of women. Over the last many years, the company has pursued an aggressive acquisition strategy, which has proved less than fruitful. With a new CEO appointed late last year, and a focus on execution and organic growth, the company finally appears to be on the path to value creation. With modest assumptions on revenue growth, improved margins, and multiple expansion, we foresee the share price approaching $40 in 2017.

HOLX generates huge cash flows. Last quarter, they generated about 200mn in operating cash flow or slightly higher EBITDA. For the year, we estimate about $725mn in operating cash flow/EBITDA or about $2.65 per share. At $21/share (Wednesday's pre-report close), that is an 8x multiple, which is quite cheap. Debt is high, but coming down with cash flow, and interest charges have dropped to about $225mn annualized. Given large depreciation and amortization, as well as impairments, cash tax payments are minimal. This allows HOLX to focus on reducing debt and leverage as well as buying back stock, for which $250mn is authorized through 2016. While we generally are not fond of large goodwill due to past high priced acquisitions, HOLX valuation already reflects that with a 12.5% operating cash flow yield. In addition, this allows cash tax payments to be reduced as GAAP earnings remain depressed with impairments.

With low single digit revenue growth, starting in 2015, and continued margin improvement, the share price should move higher over time. For example, with a modest 2015 revenue growth of 2%, and margins similar to 1H14, HOLX should generate near $2 a share in free cash flow. Given the improved outlook, and anticipated debt reduction, the shares should trade at a 13-15 multiple, implying a share price in the $27-$30 range, one year out. We would expect net debt to decline to near $3bn by end of year '15 and leverage (net debt/EBITDA) to be at 4. In addition, we would look for the company to repurchase 5-6 mn shares over the next two years. If HOLX is able to maintain its momentum, we should see free cash flow at about $2.5 per share in 2017 and debt leverage down to about 2.5, which is a stated company goal. This should allow the share price to continue to ascend towards $40 over time. While hiccups may occur, we see a management team that is geared for share performance and a price that is undervalued.

Disclosure: I am long HOLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Hologic: A Focused Image Of Renewed Growth And Share Outperformance