5 Innovative U.S. Companies Leading The Way - Part 2

 |  Includes: CERN, EW, FTI, MON, PRGO
by: Jae Jun

In my previous article, I wrote about how Forbes came up with an "Innovation Premium" and listed their "Nifty Fifty" companies innovating their way to success.

To briefly sum up, the innovation premium factor is calculated as follows:

It is calculated first by projecting a company's income (cash flows, in this case) from existing businesses, plus anticipated growth from those businesses, and looking at the net present value (NPV) of those cash flows. We compare the NPV of cash flows from existing businesses with a current market capitalization: Companies with a current market cap above the NPV of cash flows have an innovation premium built into their stock.

By using the OSV Stock Valuation Spreadsheets, I took a look at the top five U.S.-based companies: Salesforce.com, Alexion Pharmaceuticals, Amazon, Red Hat, and Intuitive Surgical. All of these have displayed exceptional growth, with their stock prices following.

Here are the next five to round out the top 10 innovative companies in the U.S. list.

6. Edward Lifesciences (NYSE:EW)

Innovation Premium: 46.9%

LTM Sales Growth: 13.1%

Five-Year Annualized Return: 33.7%

What the Company Does:

Invented the heart valve in 1960, and valve replacements are now one of the most common cardiac surgeries in the U.S.

Added Thoughts and Details:

Like Intuitive Surgical, Edward Lifesciences enjoys healthy gross margins at 70% and has been able to increase it every year or so. Only companies with pricing power have this ability, and even during the 2008 recession its margins increased.

The trend of free cash flow is healthy, as in positive and growing, and the balance sheet is rock solid with a current ratio of 4.5. However, with a P/FCF of over 50, the company is clearly not cheap.

ROE is still at a strong 17%. One thing to keep in mind is that its finished goods inventory increased from $126.4 million to $143 million, and at the same time raw materials and works in progress have increased. That suggests Edward Lifesciences is expecting large orders in the future.

Using the expected growth rate of 25%, fair value looks to be in the $90-$110 range. Not much margin of safety at current levels, but if you like the growth prospect this is an interesting name to look into.

7. FMC Technologies (NYSE:FTI)

Innovation Premium: 40.7%

LTM Sales Growth: 29.8%

Five-Year Annualized Return: 18.4%

What the Company Does:

FMC Technologies makes high-pressure fluid control equipment for the oil and gas industry. It lets subsea offshore drillers separate oil, gas, sand, and water.

Added Thoughts and Details:

The majority of companies in the oil and gas equipment/services industry have a high capex, and FMC Technologies is no exception. Reading into capital expenditure requires some researching to get an idea of whether the capex is being used for growth or maintenance.

This is whole topic unto itself, but I use Bruce Greenwald's EPV method to calculate maintenance capex. A quicker method would be to look at depreciation and amortization and assume that maintenance capex would be close to that.

In fiscal 2011, FMC Technologies' capex more than doubled to $274 million, compared to $112.5 million the year before. TTM capex has increased to $362 million. According to the Greenwald method, in 2011 maintenance capex is around $127 million out of the entire $274 million capex. This is fairly close to the previous four-year average of $124 million. Using the same concept, TTM maintenance capex has increased to $147 million out of the $370 million capex.

With the remaining amount being attributed to growth, you can see that FMC Technologies looks to be investing heavily in growth. That's one of the reasons why it made it onto the Forbes list at No. 13.

8. Cerner (NASDAQ:CERN)

Innovation Premium: 39.2%

LTM Sales Growth: 24.6%

Five-Year Annualized Return: 20.3%

What the Company Does:

It is a supplier of healthcare information technology solutions, services, devices, and hardware. Cerner solutions optimize processes for healthcare organizations. Its servers handle roughly one-third of the patient data for the entire U.S.

Added Thoughts and Details:

Gross margins have retraced to 2006 levels, with R&D falling to its lowest levels. If Cerner wants to continue its growth, more R&D is needed and should match its historical levels. R&D as a percentage of revenue used to be about 17%, but in the last year R&D expense has fallen to 13% and 12% TTM.

That is quite a big cut, and indicates that there could be a shift in the business or that management is trying to meet Wall Street earnings by cutting costs in places where it should not be. This is a red flag when it comes to quality of earnings.

But, moving on, judging from the expected growth rates and TTM cash flow levels, my estimated valuation range is quite large at $65 to $93.

9. Monsanto (NYSE:MON)

Innovation Premium: 38.6%

LTM Sales Growth: 18.6%

Five-Year Annualized Return: 8.3%

What the Company Does:

It produces genetically modified soybean, cotton, and corn seeds that make their own insecticide.

Added Thoughts and Details:

With Monsanto, we're finally getting to more reasonable valuation multiples compared the above companies.

  • P/E: 24.3
  • EV/EBITDA: 12
  • EV/FCF: 22.9
  • TTM ROE: 18%
  • TTM ROIC 17%

Balance sheet metrics show that Monsanto is healthy without any liquidity issues. The quick ratio is 1.6 and the current ratio is 2.3, with a debt/equity ratio of 0.18. Gross margins above 50% shows some real earnings power, and maintaining such a high number shows that Monsanto has a real competitive advantage over its competitors.

Reverse DCF shows that, at the current price, it has 12% growth expectations. This is in line with the growth estimates by analysts. Using the same 12% for the Graham EPS model, the fair value estimate comes out to $90 as well.

Monsanto looks to be fairly valued.

10. Perrigo (NYSE:PRGO)

Innovation Premium: 38.3%

LTM Sales Growth: 15.2%

Five-Year Annualized Return: 38.3%

What the Company Does:

It is the world's largest maker of private label over-the-counter cures, as well as a growing generic prescription business.

Added Thoughts and Details:

From a fundamentals point of view, Perrigo's valuation looks to be in the $80-$100 range. The last five years of performance in terms of FCF growth and performance measures such as ROE and ROIC is in line with the past 10 years, so its growth has been steady and consistent.

Perrigo is showing consistent high-quality returns from its investment. It is enjoying a ROE of 22%. ROE has now been above 20% the last three years. Remember that if a company can sustain this type of ROE for long periods of time, there is a competitive advantage that is being enjoyed. ROIC is also an impressive 16%.

Another point to note is that the drug business is a non-cyclical business, which is why the financial statements show great stability and strength throughout the 2008 recession. And it is now boasting its highest gross margins of 34.5%. If the economy is indicating another possible recession in 2013, companies like Perrigo will be heavily sought after.

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