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People may recognize the Hill-Rom (NYSE:HRC) brand from popular TV shows including House M.D. and Grey's Anatomy. The company's history is rooted in selling beds to hospitals and dates back to the Depression. Since then, the company has expanded into producing beds (patient support systems) with varying functions for specialties ranging from home care to extended care. Hill-Rom's primary competition is Stryker (NYSE:SYK), a company that is diversified into orthopedic and endoscopy devices. Before speaking at an investment conference earlier this month, Hill-Rom issued a press release stating that revenue and earnings are now expected to come in below prior expectations due to continued volatility in the global economy. This news sent shares down more than 10%.

While the company guided down on sales and earnings, they left their operating cash flow expectation at $290 million - $300 million for Fiscal 2012, putting their free cash flow around $230 million. This puts their price/free cash flow at less than 8x, which to us is an appealing valuation versus its peer group. There are several catalysts that could move the stock higher later in 2012.

Company

Enterprise Value

2012 Free Cash Flow Estimate

EV/FCF

Cardinal Health (NYSE:CAH)

$15.2 Billion

$1.2 Billion

12.7x

Hill-Rom

$1.9 Billion

$225 Million

8.5x

Invacare (NYSE:IVC)

$775 Million

$70 Million

11.1x

Stryker

$19 Billion

$1.7 Billion

11.2x

When the financial crisis hit in 2008, hospitals pulled back on capital spending in an effort to shore up their balance sheets. While spending has improved somewhat, it's likely that there is pent up demand at hospitals for capital equipment, such as the beds that Hill-Rom sells. While the company does experience competition in its end markets, the cyclicality in the industry keeps the number of new entrants to a low. Also, in response to hospital cut backs, Hill-Rom developed a new and improved line of less expensive beds that have done well in the marketplace. When hospitals purchase new beds, they need to be sure that the equipment will hold up well for an extended period of time, customer service meets their expectations and technology is up to date. That's why Stryker and Hill-Rom collectively hold a high percentage of the patient support system market.

In its presentation this week at the JP Morgan healthcare conference, the company outlined its capital allocation strategy through 2015. It calls for the company returning 15%-20% of its operating cash flow ($45 million for F2012) to shareholders. Currently, the company has an outstanding authorization to repurchase up to 4 million shares. More importantly, I think management could make the decision to implement a significantly higher dividend in the coming years. The company currently issues a $0.45 per year dividend, resulting in a 1.3% yield. With earnings in the Med-Tech sector projected to be fairly stable, it would behoove management to increase the dividend. Management has slated the majority of its operating cash flow to acquisitions, which should help drive EPS in the coming years. We think that the company's capital allocation strategy, an eventual rebound in hospital spending and an attractive valuation could reward long term value investors.

Source: Hill-Rom Looks Like An Attractive Stock For Value Investors