Company Background (sourced from Yahoo! Finance):
Owens & Minor, Inc., together with its subsidiaries, provides distribution, third-party logistics, and other supply-chain management services to healthcare providers and suppliers of medical and surgical products. Its services include logistics, supplier management, analytics inventory management, outsourced resource management, clinical supply management, and business process consulting. The company also offers various services comprising PANDAC, an operating room-focused inventory management program that helps healthcare providers to control suture and endo-mechanical inventory; SurgiTrack, a customizable surgical supply service that includes the assembly and delivery of surgical supplies in procedure-based totes; OMSolutions, a supply-chain consulting, customer technology, and resource management service; and technology-based services, such as WISDOM Gold, Clinical Supply, and Implant Purchase Manager solutions. In addition, it provides OM HealthCare Logistics, a customized third-party logistics and order-to-cash services. Further, the company distributes medical and surgical supplies to the acute-care market. It serves federal government, including the U.S. department of defense; and alternate-site providers, such as ambulatory surgery centers, physicians practices, clinics, home healthcare organizations, nursing homes, and rehabilitation facilities, as well as provides distribution and supply-chain management services that include third-party logistics and business process outsourcing services to manufacturers of medical and surgical products. Owens & Minor, Inc. was founded in 1882 and is headquartered in Mechanicsville, Virginia.
Analysts expect Owens & Minor to grow earnings 13.00% per year for the next five years and I've assumed they can grow at 2/3 of that, or 8.67%, for the next 3 years and continue to grow at 5.00% per year thereafter. Running these numbers through a three stage DCF analysis with a 12% discount rate yields a fair value price of $38.93. This means the shares are trading at a 2.0% discount to the discounted cash flow analysis.
The Graham Number valuation method was conceived of by Benjamin Graham, the father of value investing, and calculates the maximum price one should pay for a company given the earnings and book value. Owens & Minor earned $1.70 per share in the last twelve months and has a current book value per share of $15.91. The Graham Number is calculated to be $24.67, suggesting that OMI is overvalued by 54.7%.
Average High Dividend Yield:
Owens and Minor's average high dividend yield for the past 5 years is 3.01% and for the past 10 years is 2.54%. This gives target prices of $31.84 and $37.75 respectively based on the current annual dividend of $0.96. I'm more inclined to think the 5 year average is more realistic over the foreseeable future as the long term trend in yield has been rising. For the sake of being conservative, I'll use the 5 year high dividend yield price target in my target entry price calculation. OMI is trading at a 19.9% premium to this price.
Owens & Minor's average low PE ratio for the past 5 years was 14.78 and for the past 10 years was 16.25. This corresponds to a price per share of $27.93 and $30.72 respectively based off the analyst estimate of $1.89 per share for fiscal year 2013. Both PE ratios are relatively close so I'll use the average of the two for my target entry price. This corresponds to a target price of $29.32 with a 15.51 P/E ratio. OMI is trading at a 30.2% premium, suggesting that it's overvalued.
Average Low P/S Ratio:
Owens and Minor's average low PS ratio for the past 5 years is 0.19 and for the past 10 years is 0.20, talk about consistent. This corresponds to a price per share of $28.59 and $29.44 respectively based off the analyst estimate for revenue growth from FY 2012 to FY 2013. The price targets don't include effects due to potential share buybacks, rather it's just based off the analyst estimate for revenue and growth to be a bit conservative. Currently, their current PS ratio is 0.26 on a trailing twelve months basis. Once again I'll use the average of the two ratios in my target entry price calculation, giving a target price of $29.01. OMI is currently trading for a 31.6% premium to this price.
Gordon Growth Model:
The Gordon Growth Model is a quick way to calculate the fair value of a company using the current dividend, the expected dividend growth rate, and your required rate of return or discount rate. Assuming a constant 7.00% dividend growth rate and a discount rate of 10.00%, the GGM valuation method yields a fair price of $32.00. OMI is currently trading at a 19.3% premium to this price.
Dividend Discount Model:
For the DDM, I assumed that Owens & Minor will be able to grow dividends for the next 5 years at the lowest of the 1, 3, 5 or 10 year growth rates or 15% or the estimated earnings growth rate. In this case that would be 9.09%. After that I assumed they can continue to raise dividends for 3 years at 75% of 9.09%, or 6.82%, and in perpetuity at 5.00%. The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases. To calculate the value I used a discount rate of 10%. Based on the DDM, OMI is worth $22.49, meaning it's overvalued by 69.7%.
OMI's trailing PE is 22.43 and it's forward PE is 18.62. The PE3 based on the average earnings for the last 3 years is 21.69. I like to see the PE3 be less than 15 which Owens & Minor is currently well over. Compared to it's industry, OMI seems to be undervalued versus CAH (55.36) and MCK (28.20). All comparisons are on a TTM basis. Owens and Minor's PEG for the next 5 years is currently at 1.55 which has them undervalued versus CAH (1.98) but overvalued against MCK (1.27). A lower PEG ratio is better because it means you're paying less for every dollar of growth the company achieves.
Owens and Minor's gross margins for FY 2011 and FY 2012 were 9.90% and 10.40% respectively. They have averaged a 10.3% gross profit margin over the last 10 years. Their net income margin for the same years were 1.34% and 1.22%. Since 2003 their net income margin has averaged 1.24%. I typically like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%. They are well behind my typical target margins on both a gross and net basis, which was very surprising to find out. Since each industry is different and allows for different margins, I feel it's prudent to compare OMI to its industry. For FY 2012, OMI captured just 46.2% of the gross margin for the industry and 36.4% of the net income margin. On a TTM basis, OMI's gross profit margin was 12% while CAH's was only 5% and MCK was 6%. OMI's net profit margin was 1.18% with CAH earning just 0.40% and MCK earning 1.09%. Against their direct competitors, OMI does seem to be doing much better.
Owens and Minor's management hasn't generally bought back shares. Between FY 2003 and FY 2010 shares outstanding increased every year. Since FY 2002 shares outstanding have increased by 2.95% for an average annual increase of 0.29%. I prefer to see a company that buys back and retires their shares, which OMI clearly isn't doing on a consistent basis. Their shares outstanding have been essentially flat over the last 3 fiscal years and TTM.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Owens & Minor is a dividend contender with 16 consecutive years of dividend increases. They have increased the dividend at a 9.09%, 10.58%, 12.62%, and 15.36% rate over the last 1, 3, 5, and 10 year periods respectively. Dividend increases are based off fiscal year payouts and don't necessarily correspond to annual payouts. Their payout ratio based off EPS has averaged 38.1% over the last 10 years, but has increased from 24.2% in FY 2003 to 51.2% in FY 2012. Their payout ratio has been increasing over time which has allowed them to grow their dividend faster than EPS. Dividend growth has been trending down which is a little worrisome; however, analysts do expect for earnings to grow over 13% per year over the next five years which could allow management to increase dividends in the 5-8% range while lowering their payout ratio. I wouldn't expect to see 10%+ growth rates unless the outlook for the company changes significantly.
Owens & Minor has done a decent job at managing their cash flow. Over the last 5 years they've been able to turn 69.0% of their operating cash flow into free cash flow and 29.1% of their operating cash flow into free cash flow after paying the dividend. Their free cash flow has grown from $77.2M in 2003 to $179.5M in 2012, good for a 9.8% annualized increase, while their free cash flow after dividends has grown from $64.5M to $123.8M over the same time for a 7.5% annual increase. The free cash flow payout ratio has averaged 70.9% over the last 5 years. Once again, signs point to just average dividend growth in the 5-8% range if the growth of the company doesn't increase much faster.
Return on Equity and Return on Capital Invested:
Owens & Minor's ROE has averaged an okay 12.3% over the last 10 years and 12.8% over the last 5 years. OMI's ROCI has averaged 8.9% over the last 10 years and 9.9% over the last 5 years. Their ROE and ROCI have been just okay over the last 10 years and don't really look to improve. A positive sign though is that their debt ratios have improved over that time. Their debt to equity ratio has decreased from a high of 0.89 in FY 2002 to 0.22 in FY 2012. Debt to capitalization has also decreased from 47.0% in FY 2002 to just 18.1% in FY 2012. I like how management has been decreasing their debt levels which should help them to better weather any kind of downturn.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth, we'll now look at how Owens & Minor has done on that front. Their revenue growth since the end of FY 2002 has been excellent with a 8.5% annual increase growing their revenue from $3.96M to $8.91M. Their net income growth has just outpaced revenue growth with a 8.7% annual growth rate increasing net income from $47.2M to $109.0M. Net profit margin has essentially been flat over this time.
The average of all the valuation models gives a target entry price of $29.75 which means that Owens & Minor is currently trading at a 28.3% premium to the target entry price. I've also calculated it with the highest and lowest valuation methods thrown out. In this case, the DCF and DDM valuations are removed and the new average is $29.37. Owens & Minor is trading at a 30.0% premium to this price as well.
Assuming that Owens & Minor can grow their earnings and dividends at the rates that I assumed, you're looking at average returns over the next 5 years. In 2018, EPS would be $2.96 and slapping an average PE of 16.95 gives a price of $50.12. Over the next 5 years you'd also receive $6.28 in dividends for a total return of 47.8% which is good for a 8.1% annualized rate if you purchase at the current price. If you purchase at my target entry price of $29.75, your projected 5 year total return jumps to 89.6% for an annualized return of 13.7%.
According to Yahoo! Finance the 1 year target estimate is at $32.38 suggesting about 15% downside from Friday's closing price. Morningstar has Owens & Minor rated as a 1 star stock suggesting that it's trading well above their fair value estimate.
I think OMI could be a great investment at some time in the future as the demographics for almost every health related stock is very strong. If you check the images at the bottom of the Baxter International stock analysis you can see the trend that will continue to just grow as older people tend to require more and more health related services. Given that a lot of Owens & Minor's products/services is for one-time use products that's a trend that should lead to higher volumes and in turn higher revenues.
Unfortunately at this time I just can't invest in OMI. The valuation just seems too rich at this time, especially considering that you're needing over 13% EPS growth just to knock the P/E ratio down to around 18.5 for FY 2014. Given the low margins, low returns, and fairly high payout ratio I'd require a large margin of safety on a purchase of Owens & Minor. I wouldn't really be interested until the price per share came down to the low $30's. A big plus for OMI though is that they have a fairly small market cap at only $2.4B so there's a lot more room for growth and faster growth compared to some of the DG stalwarts like Medtronic and Johnson & Johnson. Especially given their product mix combined with the demographic trends. For now though I see it as a wait and see and due further analysis.
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What do you think about Owens & Minor, Inc.. as a DG investment? How do you think the long-term dividend growth prospects are?