Cooper Companies (COO) (or, more formally "The Cooper Companies") has done a fine job over the past few years of making up for lost time. While the company had to play catch up in the silicone hydrogel contact lens market, it is once again growing its market share and expanding its margins. Although the valuation today on these shares does not look all that compelling, investors shouldn't ignore the potential for further multiple expansion tied to ongoing share growth and margin expansion - two things that med-tech investors prize greatly.
Ongoing Growth In Fiscal Q3
Cooper did exactly what it needed to, and a little more, for the fiscal third quarter. Most importantly, the company delivered growth nearly double that of its largest market - supporting the thesis that this is a story where the fundamentals are improving more quickly than believed.
Revenue rose 8%, or 9% on a constant currency basis, this quarter, with 10% constant currency growth in CooperVision. The company saw good growth in Biofinity and ProClear One Day, with silicone hydrogel sales up 35%, toric sales up 12%, and multi-focal up 33%. CooperSurgical also performed relatively well, with reported revenue up 20% and organic revenue up about 6%.
As mentioned, improving profitability is a major part of this story. Cooper announced nearly six points of improved gross margin, tied to both a better mix (Biofinity) and improved manufacturing leverage. That said, investors need to understand that last year's gross margin was impaired by recall costs and the underlying improvement was more on the order of two points. Operating income was likewise strong, growing 49% from last year as operating expenses increased about 8%.
Plenty Of Positive Momentum In Eye Care
Given that soft contact lens wearers have to frequently replace their lenses, this is a pretty solid business in good times and bad. Cooper is doing even better, though, as it has closed the gap with its silicone hydrogel products and continues to do well with its focus on harder-to-manufacture products like toric and multi-focal lenses.
Right now Cooper is the #3 player, with approximately 16-17% market share, versus the 44% or so share held by Johnson & Johnson (JNJ). What's noteworthy, though, is that the company outgrew JNJ and Novartis' (NVS) Ciba Vision by over two times this quarter, with the larger companies posting about 4% currency-adjusted growth. If Cooper can keep up this pace, challenging Novartis/Ciba for #2 is not out of the question (Novartis currently has about 22-24% share), particularly given Cooper's relationship with Luxottica (LUX) (owner/operator of Pearle and LensCrafters).
But Don't Ignore Surgery
One of my criticisms of Cooper in the past has been management's reticence to expand and leverage its surgical business (a business largely built around ob/gyn products and instrumentation). I like the company's approximately $200 million deal for Origio, a Danish company with strong share in the IVF market, particularly given the opportunities to leverage those products through Cooper's U.S. sales force and the private-pay nature of the IVF market.
Cooper doesn't spend a lot of capex on its surgical business, and the company has the potential to leverage the heck out of small transactions by adding incremental products to what the sales force already sells. Although this business is smaller than rival units at JNJ, Bard (BCR), and Boston Scientific (BSX), it's focused, it's profitable, and it generates good cash flow.
The Bottom Line
My primary issue with Cooper right now is the valuation. The stock has done quite well since late 2008 and pullbacks in 2011 and earlier this year. Even if the company can build its free cash flow conversion up to 20% of revenue (a pretty solid level relative to Bard, JNJ, and other med-techs), revenue growth in the mid-to-high single digits is not going to get it done from a valuation perspective.
On the other hand, strong cash flow can help accelerate debt repayment and/or additional acquisitions, and there's ample growth potential left in the contact lens market, both here and abroad. Accordingly, while I'd probably wait for a selloff before buying these shares as a new investor I'd be in no hurry to sell even if the valuation looks a little rich.