This past week we were reviewing our portfolio of stocks during trading when we noticed that one of our less covered stocks dropped dramatically late on a Friday afternoon. Of course, when we say dropped, we mean an "off the edge of a table" drop. A quick search of the Internet quickly revealed a single link to the story that was the cause of the drop. The company at issue in the story is Halyard Health (NYSE:HYH), a provider of: 1) Surgical and Infection Prevention ("S&IP") and 2) Medical devices. The link is to a story by 60 Minutes to air on May 1, 2016. Few things scare investors more than a negative 60 Minutes story that involves a company that they own shares in. The story involving HYH discusses allegations that the company supplied faulty protective equipment to hospitals during the most recent Ebola outbreak. The story also mentions that HYH sold such equipment to the U.S. government's Strategic National Stockpile for use in future outbreaks and emergencies. In particular, the story discusses HYH's MICROCOOL Surgical Gown, which is supposed to meet strict industry standards to be impermeable to blood and body fluids containing dangerous viruses like Ebola cannot pass through. Allegations against HYH are that its gowns did not consistently meet industry standards. HYH, however, responds to such allegations by stating that the allegations are not based on facts and that they "get less than one complaint for every million gowns sold." Although the headline risk of this litigation is intimidating, we believe any selloff in HYH's shares will be overdone.
It is important to know that the allegations in the 60 Minutes story are not new. In fact, the allegations and the lawsuit are over 18 months old. Yet the market is reacting as if the lawsuit is a new threat to HYH. In reality, however, in late 2014 a law firm instituted a class action lawsuit against Kimberly-Clark Corp (NYSE:KMB) (from which HYH was spun off) for more than $500 million, alleging that the company committed fraud by marketing and selling some of its surgical gowns as protection against Ebola. It is unclear to us from our review of the spin-off agreement whether KMB is indemnifying HYH for damages arising from this lawsuit or whether HYH is assuming all of the damages responsibility for the lawsuit. What we do know is that the 60 Minutes report is new and a 60 Minutes report critical of a company is never a near-term positive for a company and its stock. Remember, however, that the report is focusing on a single product that HYH sells among many products. Remember also that for all the strong allegations of a plaintiffs' attorney in the litigation, these class actions are typically settled many years after the filing of the action for much less money than the amount originally sought at the outset of the litigation. Finally, as we will detail below, HYH is in the midst of a multi-year transformation away from S&IP products and towards medical device products. Our conclusion in regard to the 60 Minutes story is that the sell off arising from such a story is a buying opportunity for intermediate and long-term investors.
For those unfamiliar with HYH, the company has two divisions. Its S&IP division offers sterilization wraps, surgical drapes and gowns, facial protection products, protective apparels, and medical exam gloves for the prevention of healthcare-associated infections. The company's medical devices division offers a portfolio of products focusing on pain management and respiratory and digestive health to enhance patient outcomes. The S&IP division is currently the company's largest division. As seen in the company's most recent earnings report, its revenues from its S&IP division continue to fall due to lower selling prices of exam gloves and sterilization products and lower sales volume in surgical drapes and gowns and protective apparel. The continuing positive in HYH's quarterly results, however, continues to be its medical devices division. To address the difficult business environment it faces and ensure long-term growth, HYH is stabilizing its S&IP division while expanding its growing medical devices division through internal innovation and acquisitions. As part of its plan to expand its medical devices division, HYH announced its acquisition of Corpak MedSystems ("Corpak"). Corpak develops, manufactures and markets a broad portfolio of high-quality, branded enteral access devices. With the acquisition of Corpak, HYH took its first major step in transforming the company into a leading medical devices company and positioning its business for long-term growth. We believe that investors with an intermediate or long-term horizon should strongly consider acquiring HYH's shares on any 60 Minutes story weakness to capitalize on the company's transformation towards the growth oriented medical devices market and away from the price competitive S&IP market. A company such as HYH will thrive as a medical devices company as it will be selling into healthcare markets with aging populations around the world. Further, we believe the further HYH moves towards becoming a medical devices company with a strong future of consistent growth the more likely the company will become a takeover target.
The 60 Minutes story in regard to HYH hospital gowns is clearly a negative near-term story, but such stories and any resulting litigation tend to fade into the background rather quickly. In HYH's case, there have been no known injuries resulting from the allegedly defective gown product. The end result of the class action litigation against HYH is a likely settlement for an amount much less than is being asked for. Looking past the 60 Minutes story and almost two-year-old litigation, HYH has a lot of positives that we recognize and the financial media also recognizes. In fact, Barrons recently published a positive article about HYH indicating their belief the company's shares could double in three years due to its ongoing transformation (that we have been highlighting since the company was spun-off from KMB). As noted above, HYH is making a strong move into the healthier medical devices market as shown by its recent Corpak acquisition. The Corpak acquisition is the first major step by HYH in its transformation plan but it will not be the last. We see the company stabilizing its S&IP division while making additional smaller acquisitions to build up its medical devices division in the near and intermediate term. The company's underperforming S&IP division currently accounts for the majority of its total sales, but with each acquisition of a medical devices company the S&IP division will account for less and less of total sales.
HYH's forward price-to-earnings ratio is about 17.60 based on earnings estimates of $1.60 for 2017. We believe that potential investors should take advantage of any selloff of HYH's shares due to the 60 Minutes story. We also believe that investors should consider that HYH is a leader in the markets it participates in. Another positive for the company is that populations of aging people around the world favor its marketplaces and its products. Investors, however, will want to invest in the company's shares in anticipation of its transformation showing results. In addition, we should note that in a sign of confidence in the company's transformation plan, insiders purchased the company's shares in the $30 to $31 price range in late 2015. Finally, as indicated above, we believe that HYH will become an acquisition target in the intermediate term as the company's transformation into a medical devices company takes place.
Disclosure: I am/we are long HYH, KMB.
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.