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Ben Reynolds
Ben Reynolds
Articles (740)  | Author's Website |

This Undervalued Small-Cap Health Care Distributor Has Big Upside

See why Owens & Minor is seriously undervalued -- and how it can easily deliver double-digit returns over the next 5 years

July 11, 2018 | About:

Shares of health care distributor Owens & Minor (NYSE:OMI) have declined 45% over the past year. The entire health care distribution industry has come under pressure, due to greater focus on health care costs. In addition, the threat of Amazon (NASDAQ:AMZN) making a big push into the health care distribution industry has only added to the negative sentiment.

The good news is, Owens & Minor’s steep drop has made the stock very cheap on a valuation basis. Owens & Minor is a small-cap stock, with a market capitalization of just $1.08 billion. It is a member of the Russell 2000 Index. This could result in higher growth potential for the stock, as the company may have more room to grow than the industry giants.

Not only that, but the stock now sports a 6.0% dividend yield.

Owens & Minor has potential for compelling returns over the next five years, which is why the stock is a major opportunity for value and income investors.

Business overview and growth catalysts

Owens & Minor is a health care distribution, transportation and data analytics company. It supplies hospitals and a wide range of health care providers with health care products. The company supplies over 200,000 medical and surgical supplies to over 4,000 U.S. hospitals. The company also services group purchasing organizations, government agencies and at-home health care customers.

Conditions have become much more challenging for Owens & Minor over the past year. Adjusted earnings per share declined 26% in 2017 due to lower revenue and higher investment spending to turn the business around.

Fortunately, conditions have improved to start 2018. Revenue increased 1.7% in the 2018 first quarter, thanks to 2.2% revenue growth in the core Global Solutions segment, which represents approximately 99% of total revenue.

First-quarter earnings per share declined by 2% from the same quarter a year ago, but the company’s fundamentals have begun to stabilize.

Owens & Minor has a long runway of growth up ahead of it, primarily because of the aging population. The Baby Boomer generation is over 70 million strong, meaning health care demand in the U.S. is only going to rise in the years ahead. It is likely that health care spending will outpace GDP growth in the U.S. going forward.

To capitalize on this emerging growth opportunity, Owens & Minor is accelerating its investments in mergers and acquisitions. For example, last year the company acquired Byram Healthcare, which boosted Owens & Minor’s at-home healthcare business. Byram contributed $118 million to Owens & Minor’s revenue in the first quarter.

Another major deal was the $710 million acquisition of Halyard Health’s Surgical & Infection Prevention (S&IP) business, which was completed on May 1. This was the largest transaction in Owens & Minor’s history, and it gives it a greater presence in new product categories and geographic markets. The S&IP deal expanded Owens & Minor’s portfolio to include new medical supplies like sterilization wraps, surgical drapes and gowns, facial protection, protective apparel and medical exam gloves. These acquisitions will help the company enter new, high-growth product markets.

Expected return potential

If Owens & Minor can turn itself around and return to growth, the stock could be a bargain at the current price. Analyst consensus is for Owens & Minor to generate earnings per share of $2.00 in 2018. As a result, the stock trades for a price-earnings ratio of just 8.7. The stock could easily earn a higher valuation, if the company returns to earnings growth, as expected.

Over the next five years, a price-earnings ratio of 18 is not unreasonable, given that it is the average valuation over the past 10 years. If Owens & Minor stock returns to a price-earnings ratio of 18, shareholders buying at the current price would earn annual returns of 16% just from an expanding valuation multiple.

Owens & Minor stock also has a highly attractive 6.0% dividend yield. This is more than three times the average dividend yield in the S&P 500 index, which makes Owens & Minor stock particularly appealing for income investors such as retirees. The $1.04 annual dividend payout appears to be secure, as Owens & Minor is expected to maintain a dividend payout ratio of 52% for 2018. A payout ratio slightly more than half of annual earnings indicates the dividend is highly sustainable, especially if the company can return to earnings growth moving forward.

In addition to valuation changes, shareholders will also benefit from the company’s earnings growth and dividends. Assuming 16% annual returns from valuation expansion, 8% earnings growth and the 6.0% dividend yield, Owens & Minor stock could generate annual returns of 30% per year over the next five years.

Disclosure: I am long Owens & Minor.

About the author:

Ben Reynolds
I run Sure Dividend, a website that finds high quality dividend stocks for long term investors using the 8 Rules of Dividend Investing.

Visit Ben Reynolds's Website

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