Owens & Minor (NYSE:OMI) is an interesting business in the medical supply/healthcare supply sector. The company was a high-yielder favorite with a dividend yield of above 5% before the company decided to slash the dividend due to an earnings crash. The current dividend stands at $0/share.
While the company has recovered earnings momentum to, and above pre-cut levels, I believe the risk/reward potential for the company hasn't exactly improved significantly. Oh, you can argue from a valuation-based perspective that there is upside to OMI. We will go through that. But I don't believe this should necessarily be viewed as all that favorable, given trends.
While the company's trends and valuation have gone straight up, the company still remains at a risky position. The latest set of results we have are the 1Q22 results, and these were fairly positive, all things considered.
OMI has managed a strong performance for the first quarter of 2022. The pandemic-infused momentum from 2021 is carrying over into the new year. Given the lower expense load after the dividend elimination, the company also has very stringent capital allocation approaches.
Revenues were up year-over-year in both the company's product and service segments, as well as the patient direct segment, with most growth seen in the patient direct segment. The company's subsidiary Byram is leading growth here, at well ahead of market growth rates. The company 0.9% margin expansion despite ongoing headwinds, and generated $118M worth of adjusted EBITDA, which was a 22% sequential growth even to the strong 4Q21 quarter. Operational cash flow has recovered, and the company generated around $80M here.
Perhaps more importantly, OMI finished the acquisition of Apria, the largest M&A in OMI history. The company's target here is strengthening the direct-to-patient home market, which goes hand in hand with overall current industry trends where focus is offering patient more direct access to services and products. OMI is currently integrating Apria, and once fully done, this company will enable patients to be served by OMI through hospitals and directly into the home. The company's current business model only starts with manufacturing, but then moves to supplying and serving the patients regardless of where they happen to be cared for, making the company essentially vertically integrated.
OMI begins with raw materials and goes all the way to finished goods, and also owns proprietary technologies and their own brands, including HALYARD, as well as their own line of PPE. Unlike other businesses, OMI does not source significant portions of its products from third-party vendors.
For this example, I'll use non-woven, spunbound fabric-based S&IP products. It all starts with the production of the fabric in our North Carolina facility with polypropylene supplied primarily out of Texas. This fabric is then converted into surgical masks, isolation gowns, N95, drapes, surgical gowns, wrap, as well as other S&IP products. Conversion of this fabric to finished goods is then completed in our facilities in Texas, North Carolina, Mexico, and Honduras. These products are then transferred to our centralized distribution centers, which is a much shorter delivery route than products shipped from China.
(Source: Edward A Pesicka, Owens & Minor 1Q22)
In a way, it's very sad that the company took a turn south those years ago, because looking at OMI objectively, it's actually a great business. It's a business that produces a lot of its products locally, which insulates them somewhat from the supply chain problems currently plaguing international processes.
The biggest challenge with Owens & Minor that I see is the degree of pandemic tailwind that's a non-recurring sort of positive, and how the company will look once this non-recurring positive is gone. The risk is also company fundamentals, which are quite poor due to the Junk-rating in terms of credit, the zero dividend and the recent history.
Sure, OMI has navigated inflation impacts and consider its company structure advantageous in a way that future cost inflation will be mitigated as well, but there are continued uncertainties and volatility in terms of earnings - such as EPS, which is down significantly on a sequential basis.
The company also continues to have a fair amount of debt, reflected by the unfavorable credit rating, and interest rate increases will impact the company's variable debt and interest payments. Further, there are massive inflation trends in commodities such as PU/PP, one of the key raw materials in OMI manufacturing. Demand for PPE will likely decline somewhat as the pandemic continues to wind down.
Overall and on a high level, I would say that Owens & Minor has performed quite well, and there's plenty of room for the company to grow. It's just that the poor legacy that the company established a few years back takes a long time to recover from. If the company had still been as cheap with a 40-50% upside on an annual basis, my stance would have been somewhat different.
However, at current levels of valuation, which we'll go into here, it's my view that the company's forecasts gives a potentially insufficient overall upside, when we're considering the company's fundamentals.
The fundamentals that are no yield, no investment-grade credit rating, and a poor recent-term history.
There are companies out there that have a similar upside to this business, that don't suffer from these, frankly, clear downsides.
Let's take a look at that valuation, seeing as the company's share price has actually recovered quite nicely.
Owen's & Minor's valuation chart gives us insight into exactly what happened that caused the company to decline as it did. In simple terms, earning went into the toilet, the dividend was cut, and the market declared the company "worth very little."
Obviously, the market believes that the company has recovered momentum and fundamentals as a result of improvements, M&A's and what was mentioned in the previous segment. OMI has been a solid investment from trough valuations based on this, but the question is of course how we move forward from this.
There is no implication that the dividend is going to be restored any time soon, which means that the sole upside we're having here is capital appreciation. Given that much of the upside is realized, the company's upside is based on average P/E-valuations on a 5-year basis, which includes the dip years including 2019-2020.
The upside based on a 10-11X forward P/E is around 10-12% annually, given the zero dividend for the company. The expectation for the company's earnings is a dip in 2022, with a 16% EPS drop.
Forecasts are, as you might expect, not great for the company. The analysts have a 38% 10%-adjusted negative miss tendency, with several large 10%+ misses in recent history. This makes forecasting this company's actual trends and numbers difficult.
S&P Global meanwhile, fully believes in a full normalization of a 12-15X P/E multiple for the company. 6 analysts give the company a range of $43-$68 per share, with an average of $58.8 per share. 4 out of 6 analysts currently have a "BUY" rating on the company.
It's understandable that the view on Owens & Minor is as split as it currently is. The company has structural advantages and upsides in a inflationary/supply-chain-pressured situation given its solid manufacturing situation. At the same time, it's less than 2 years ago that the company left behind one of the most challenging situations in its corporate existence, which turns this into more of a risky situation.
In the end, I always err on the side of caution. A 10-15% annual upside is great, but the fact is that we have such upsides in company with much better overall fundamentals. In fact, we have potential investments with 30%+ annual upsides that are a-rated and have a dividend that's intact. There is, to my mind, no reason when such companies exist, to invest in a currently inferior-valued alternative known as Owens & Minor.
In a similar situation to Tupperware (TUP), I, of course wish that I'd had the heart to invest at trough valuations here. The upside at trough would have been over 100% - well over 100%. From trough valuations, the RoR possible was over 1,100%.
So, it could have been a great investment, but it's not an investment that I would ever make given the level of involved risk here. It's outside of my risk comfort zone - and that's the same reason why something like TUP, I wouldn't do. The risk is that, if investing $10,000, you instead lose parts of or the entire investment if It instead goes down - which it very well could have done.
This brings me to my thesis for OMI.
My thesis for OMI is as follows:
A good example to what might happen if things go bad for a company like Owens & Minor is Tupperware today, which is dropping 30% due to bad guidance, and is down more than 40% since my last "HOLD/Don't buy"-article. I'm not saying this will happen to OMI, but I'm saying risk here is elevated, compared to what you could, or should be buying.
I remain on the sidelines with OMI.
Thank you for reading.
This article was written by
36 year old DGI investor/senior analyst in private portfolio management for a select number of clients in Sweden. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.
I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.
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