Immucor: A Razor and Blades Franchise That Looks Cheap

| About: Immucor, Inc. (BLUD)

Immucor (NASDAQ:BLUD) is a high-quality stock and formerly an expensive growth stock that the market deemed worth >30 times earnings for the better part of the past decade. The company manufactures machines that perform various blood tests and sells the reagents that are required for each test. There are only two other companies – a subsidiary of Johnson & Johnson (NYSE:JNJ) and Bio-Rad (NYSE:BIO) – that offer a full line of reagents and testing machines. The stock is not exactly trading for a distressed price, but the current price might allow a patient investor to cheaply purchase shares in a strong franchise with strong long term growth potential.

The company currently trades at 16x TTM earnings and 13x TTM earnings if you net out the cash ($84m in TTM net income, $1.35 mkt cap, $0.25bn cash). On the face, this is not the kind of multiple that attracts a value investor, but investing is not done solely based on one statistic. The company has a cash-adjusted TTM ROE of 33% and a ROIC of 30% achieved with no leverage and minimal capex requirements. The company achieves these great returns through its business model and competitive advantage.

The company sells its machines in order to get long-term contracts guaranteeing the purchase of reagents by customers at a fixed price. These contracts usually secure annual price increases as well. This is a genuine razors and blades business model. The reagents (blades) garner 80% gross margins. Once the company sells or rents a machine to a customer, it is guaranteed a steady stream of high margin revenue.

Recently, the company began disclosing how many machines it has placed that are generating revenue. Just between August and November 2010, the companies placed machines grew from 1,392 to 1,478. While I wouldn’t extrapolate this growth, the company is still placing new machines which will drive the top and bottom line.

The growth in the business was phenomenal from 2005-10, with earnings and revenue doubling and powering right through the recession. Growth has slowed down in the recent year, despite more machines being placed with customers and a healthy backlog. The company states that many of the blood tests its products perform have a discretionary component.

According to the CEO, 51% of transfusions are for cardiovascular disease and skeletal diseases (joint and hip replacements). These are generally procedures that are associated with the elderly. While people have been putting off what procedures they can, the sheer volume of baby boomers will begin to move the needle along with the increased machine placement.

There are several risks thought with this company. The Department of Justice recently dropped an investigation in price fixing and monopolistic behavior on behalf of the company and Johnson & Johnson. While this investigation was dropped, it spawned a class action lawsuit on behalf of several customers.

The company’s products are a small part of the overall cost structure of its operations, but the company and its competitors are well aware that they serve a crucial and essential function. While one takeaway would be that the company has a very strong moat, there are some signs that it could still be affected as a result of illegal practices. I’m not a legal expert. These cases can go either way, although it's no surprise to see customers annoyed by the high prices they pay and the lack of alternatives.

Another risk is a not yet resolved issue with the company’s manufacturing facilities. The FDA has inspected the facility and not been entirely satisfied. While the company has taken measures to fix the problems brought up by the FDA, issues still remain. It would be very difficult to shut down the company, though, because it does not carry a lot of excess inventory and its products play a crucial role in the day-to-day operations of hospitals. The details of the issues have not been disclosed, but the company has been improving its facilities and there would be a large disruption in many hospitals if the company was forced to cease production at its facilities.

For a patient investor willing to tolerate the downturn in the cycle, the combination of increasing machine placement and increasing long-term demand could potentially prove profitable. An additional long-term driver of growth is the company’s somewhat unique automation strategy. Its “edge” relative to competitors is that its machines don’t require a full-time skilled technician to analyze blood samples and results. This minimizes errors as well as reduces the labor costs of the blood banks, labs, and hospitals that are its main customers.

An additional catalyst in the stock could be the involvement of ValueAct, a hedge fund whose involvement in another company I have touched upon before. This collection of attractive long-term characteristics will likely allow the company to overcome the short-term bumps it has encountered in its growth trajectory as well as legal and operational difficulties.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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