Halyard Health: First Major Acquisition Accelerates Transformation

| About: Halyard Health, (HYH)


The company’s surgical and infection protection division, its largest division, continues to experience weakness while its smaller medical devices division is experiencing growth.

The company is executing its strategy to transform into a medical devices company through internal innovation and acquisitions.

In the near term, the company is seeking to stabilize its surgical and infection protection division while growing its medical devices division.

The company recently acquired the medical device company Corpak, a developer, manufacturer and marketer of a portfolio of branded enteral access devices.

We believe that investors should strongly consider investment in the company’s shares before the overall market fully appreciates the benefits of the company’s transformation.

Halyard Health's (NYSE:HYH) shares have traded as if they were riding on a roller coaster ride in its short time as an independent company spun off from Kimberly-Clark (NYSE:KMB) in late 2014. In 2015, the company's shares traded as high as about $50 a share before tumbling back into the low $30 range in late 2015. In early 2016, HYH's shares plummeted into the low $20 range as a difficult market environment adversely effected the company's largest division. To remind investors, HYH provides health and healthcare supplies worldwide through its two divisions: 1) surgical and Infection Prevention ("S&IP") and 2) medical devices. The 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 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. Since becoming an independent company, HYH has experienced weakness in its S&IP division while experiencing growth in its medical devices division. As a result, HYH has been working to stabilize and improve results in its S&IP while positioning itself to execute its long-term strategy of rebalancing its product portfolio to focus on its higher growth medical devices division.

In HYH's most recent quarter, it reported adjusted earnings of .57, a 64.2 percent decrease from the year-ago quarter due to lower net sales and higher operating expenses. Net sales decreased 8.6 percent from the year-ago quarter to $401.4 million due to adverse currency effects and weakness in the S&IP division. S&IP division sales decreased 12 percent from the year-ago quarter to $263 million due to lower selling prices of exam gloves and sterilization and lower sales volume in surgical drapes and gowns and protective apparel.S&IP operating profit was $27 million, down from $48 million reported in the year-ago quarter due to lower volume and selling prices, higher manufacturing costs.The company's medical devices division sales increased 5 percent to $134 million due to increased sales of interventional pain solutions in North America. Operating profit for the medical devices divisions was $21 million, a decrease from $28 million reported in the year-ago quarter due to higher operating expenses.

HYH's latest quarterly results are representative of the business climate the company has been facing and continues to face. The company's 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 bright spot in the company's results, however, continues to be the company's medical devices division.With HYH's most recent results in mind, it is important to note that the company has set out a course for it to experience growth over the intermediate and long term. As noted above, the company plans to stabilize its S&IP division while expanding its growing medical devices division through internal innovation and acquisitions. As part of HYH's plan to expand its medical devices division, as noted in detail below, the company recently announced its largest acquisition to date to expand its medical devices division. Upon the announcement of such acquisition, the company's shares surged upward in a positive reaction to the announcement. We believe that investors with an intermediate or long term horizon should strongly consider acquiring HYH's shares on any overall market 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 bright future the more likely the company will become a takeover target.

Acquisition is first significant step in transformation towards medical devices

In early April 2016, HYH announced its acquisition of Corpak MedSystems ("Corpak") in an all-cash transaction of $174 million. Corpak, develops, manufactures and markets a broad portfolio of high-quality, branded enteral access devices. Corpaks's portfolio of products, including nasogastric tubes, complement HYH's existing enteral feeding products and creates a complete offering of enteral feeding solutions for patients and caregivers. Corpak's sales for fiscal year 2015 totaled about $54 million. HYH is funding such acquisition with a combination of cash and the company's revolving credit facility. The company also expects to close on the transaction in the second quarter of 2016.

HYH indicated that Corpak's market-leading enteral feeding portfolio would enable to serve doctors and their patients with a broader set of products. HYH also noted that Corpak's business works well with its existing medical devices division with slightly higher sales growth and similar gross margins. 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. HYH expects the Corpak acquisition to be $0.05 accretive to the company's fiscal year 2016 adjusted dilutive net earnings per share excluding acquisition, integration-related and intangible amortization charges and $0.15 accretive for fiscal year 2017. As a result, the company revised its previously announced full year 2016 adjusted diluted EPS guidance to $1.50 to $1.70. We believe that this first major acquisition by HYH is symbolic of the company's steadfast effort to move towards the healthier medical devices market. We also believe that the upward surge of the company's shares after the announcement of the acquisition shows that investors recognize the significance of such acquisition towards HYH's transformation plan. Finally, we should note that the Moody's investment service rated the acquisition of Corpak as credit positive.

Our view

Since early 2015, we wanted to own more shares of HYH. In early 2016 we decided to purchase HYH shares after the company announced earnings. In a classic "you cannot time the market" moment, we bought the company's shares at about $33 only to see the company's shares trade down almost everyday during the overall market selloff until bottoming out at about $22. We were down about 30 percent in a matter of weeks. Boy did we feel stupid. Well, we thought about doubling down on the company's shares at about $22, but before we could the company's shares rebounded to the $25 to $28 range. Soon after, Barrons 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). Not long after, HYH announced the Corpak acquisition and the company's shares rose again as the market approved of the acquisition. The Corpak acquisition is the first major step by HYH in its transformation plan but it will not be the last. Look for the company to make additional smaller acquisitions to build up its medical devices division in late 2016 and throughout 2017. As we have noted in previous articles on HYH, the company clearly understands the problems it faces and is working to resolve such problems. The company's underperforming S&IP division accounted for about 80 percent of its total sales (prior to the Corpak acquisition), and, therefore, is the near-term focus of the company's management. As HYH management stabilizes and improves the performance of its largest division, management also is targeting higher growth for its medical device division through innovation and acquisitions as the division participates in a market that is experiencing higher growth.

HYH's forward price-to-earnings ratio is about 19.45 based on earnings estimates of $1.60 for 2016. We believe that potential investors should consider a transforming healthcare company such as HYH that is a leader in the markets it participates in as demographics and the aging of populations around the world favor companies participating in such a marketplace. As the company begins to show results from its transformation into a medical devices company, the company's shares will respond in a positive manner. Investors, however, will want to invest in the company's shares early before the market bids up the company's shares as the company's transformation shows results. Further, 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 noted above, we believe that HYH will become an acquisition target in the intermediate term as the company's transformation into a medical devices company becomes more advanced.

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.

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