We initiated positions in Alcon (NYSE:ALC), the largest ophthalmic surgical device company and second largest vision care company in the world. Alcon started trading in April after being spun out from pharmaceutical manufacturer Novartis, where Alcon spent close to a decade as a subsidiary.
We think Alcon has attractive prospects for sustainable double-digit earnings growth, driven by several near -term and long-term company-specific and secular trends. First, Alcon has a leading global share in advanced technology intraocular lens (ATIOL) but it has yet to launch a few key products in the U.S., which happens to be its largest market. ATIOL uptake tracks in-line with an aging demographic. These artificial lenses are used to replace clouded natural lenses (cataracts) and simultaneously alleviate other common eye problems such as astigmatism and the increasingly prevalent presbyopia. Over the past five years Alcon was slower to market in the U.S. due to nothing more than Novartis prioritizing pharmaceutical R&D ahead of Alcon's ATIOL franchise. More recently, Alcon has no longer needed to prioritize R&D spending relative to pharmaceutical R&D and will be able to continue allocating toward its best ideas, including faster growing, higher margin ATIOL products, including next generation technologies (such as accommodative ATIOL) from organic and inorganic means. We estimate Alcon's ATIOL business will be able to grow 15-20% per year over the next several years, more than offsetting its flat but steady, legacy monofocal lens franchise, and grow well in excess of the mid-single digit growth rate of the surgical eyecare market.
Second, Alcon controls around 50% of the installed base of ophthalmic surgical equipment, globally, which drives a steady consumables business that grows in-line with procedure volumes for cataracts, vitreoretinal diseases, and refractive errors. We expect cataract and refractive error surgery volumes to grow in the low-to-mid single digits and vitreoretinal disease surgeries to grow faster, as diagnosis and treatment opportunities expand in-line with the highly correlated growth in diabetes. We also expect Alcon to launch a new equipment platform in the next two to three years, that should drive incremental consumable growth.
In addition, Alcon has the second largest market share in optical health care, including contact lenses, contact lens care, and over-the-counter treatments for dry eye. Over the past year Alcon has embarked on an expansion program to build out its daily contact lens manufacturing capacity and enter into previously untapped segments, particularly in the mid-priced tier. We expect this capacity to come on-line later this year and into 2020, which should drive an acceleration in daily contact lens revenue growth. We estimate daily contact lenses generate two to three times more revenue per year than reusable contact lenses. We view the high up -front capital expenditures as significant barriers to entry, as even Novartis would routinely shelve capacity expansion despite being #2 in market share. This should allow for relatively unimpeded growth as plants take three to four years to get to optimal production rates. In addition, we think Alcon has recently developed novel manufacturing solutions that should reduce capex requirements by a third, and significantly reduce cost per lens and generate double-digit returns for this segment.
Finally, over the next several years we expect Alcon to be able to expand gross margins by several hundred basis points, both from manufacturing efficiencies as well as a mix shift to higher-margin ATIOL and surgical products. Further, as Alcon completes stand-alone overhead investments, along with revenue and gross margin dollars acceleration, we expect the Company to leverage its overhead and drive overall operating margin expansion in to the mid-20%’s, compared to the 17% margin reported in 2018. This margin expansion and revenue growth should yield an attractive mid-teen earnings per share growth rate over the next several years.
In summary, we think Alcon's leading market position in ophthalmic surgery and optical health will be successfully leveraged into double-digit earnings per share growth, as the Company’s independence allows for more rational and aggressive capital allocation decisions over the next several years. We initiated a position during the quarter and would expect to add to that position as more attractive absolute valuation multiples present themselves.
From David Rolfe (Trades, Portfolio)'s second-quarter 2019 Wedgewood Partners letter.
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