Description
Good values are hard to find. Between the overpriced high growth momentum stocks trading at a premium and beaten down poorly performing companies deserving their low multiples, you hope to find a company that has decent prospects and decent prices. Hospira treads on the edge of being too high by some metrics, but has potential to grow as a new company in a sector that has some long term appeal for growth.
Hospira was created from the core of the hospital products segment of Abbott Labs. The took place in May 2004. Hospira's business concentrates on hospital care products that include equipment used in intravenous care,infusion systems, monitoring systems, drug delivery systems and kits used for procedures such as cardiac catheterizations. Hospira also produces medications(generic) and patient care solutions such IV care products(Ringer’s solution) and normal saline. They have an extensive list of products that can be viewed at their website:
www.Hospira.com
http://www.hospira.com/Products/Default.aspx
Hospira was incorporated in Delaware as a wholly owned subsidiary of Abbott Labs on September 16, 2003, expressly to create a separate company to manufacture and sell hospital products. Shortly thereafter, in April 2004, Abbott transferred the assets and liabilities comprising the hospital products business to Hospira and distributed all of the shares of Hospira’s common stock to Abbott shareholders in the form of a stock dividend -- for every 10 shares of Abbott stock, one share of HSP was awarded. Hospira has been a stand-alone business for nearly 6 months. They have 15 manufacturing facilities and more than 14,000 employees.
Business segments include:
--Medication delivery systems and critical care devices
--Specialty injectable pharmaceuticals
--Injectable pharmaceutical custom manufacturing services
Customers include:
--hospitals
--alternate site clinics
--home healthcare providers
--long-term care facilities.
Medication Delivery Systems and Critical Care Devices
This segment manufactures and markets the electronic equipment used to infuse drugs, nutrition, intravenous solutions and pain medication. They also distribute the premixed drug solutions and nutritional supplements. Next time you are in a hospital, notice the ubiquitous presence of this equipment in every room(either that or catch the next episode of ER)
Intensive care rooms require even more sophisticated equipment. Hospira also supplies the instruments capable of monitoring cardiac function, blood flow and oxygen saturation.
Specialty Injectable Pharmaceuticals
This segment focuses on the manufacture of generic injectable medications. Their catalog includes more than 100 generic injectable products in more than 600 dosages and formulations. They also have a number of proprietary branded specialty products. This is an impressive number of medications for an essentially new company. All of Hospira’s injectable pharmaceuticals include unit-of-use bar code labels that can be used to help promote safety at the patient bedside and reduce the risk of medication errors.
Hospira’s One 2 One Global Manufacturing Services
This segment deals in custom manufacturing services for formulation development, filling and finishing of injectable drugs. Research and development is required, as they contract to provide specific proprietary medications in injectable forms for customers. They fill and finish those and other drugs into containers and packaging selected by the customer. These customers then sell the finished products under their own labels. Firm Analyst
As a new company, there is not much baggage yet, but there are a few minor matters to consider
Litigation
Hospira is already peripherally involved in legal actions. Litigation is a hangover from the parent company, Abbott and involves an investigation into pricing of medications. Hospira, through Abbott, is exposed to a number of purported class actions on behalf of health care insurers and other third-party payors.The suit alleges that Abbott and other pharmaceutical companies reported false or misleading pricing information in connection with federal, state and private reimbursement for certain drugs. Many of the products involved in these investigations and lawsuits are Hospira products. Thus far Hospira is named as a defendant in one drug cost case in Texas. There seems to be little risk that would cause earnings to suffer in the near term.
Pension plans
Hospira was required to continue the existing pension plan established at Abbott for qualified employees. That fund is now frozen. A comprehensive accounting of the details of the plan regarding funded status is not available and should be looked for in the 10K when available. A few figures are available and show a not overly burdensome residue from Abbott. Abbott was required to keep all the obligation for every retiree up until the date of spinoff.
Net accrued balance medical plan: $17.8 million
Net accrued balance medical and dental : $85.6 million
These amounts are not crushing in light of the plans now being frozen. Obligations should be restricted to current plan members and should not escalate uncontrollably. A more thorough accounting should be available in the annual report.
As a result of its evaluation of its benefit programs, they are offering an enhanced 401K, the freezing of the U.S. non-union pension plan and the discontinuation of the U.S. non-union post-retirement medical and dental plan. The discontinuation of the U.S. medical and dental plan was effective May 1, 2004. Effective December 31, 2004, the U.S. pension plan will be frozen. Eligible employees covered by the plan will continue to earn benefits and will be entitled to all benefits earned when they retire. These steps will help to limit future pension benefits expenses which can become a real drag on a company’s earnings.
Debt
Interest and other expenses, increased approximately $2.2 million for the quarter ended June 2004, compared with the same period in 2003. The increase was primarily due to interest relating to short-term borrowings and the issuance of the senior unsecured notes to repay the senior unsecured credit facility that Hospira incurred as part of the distribution.
June 2004, Hospira completed an underwritten $700 million offering of $300 million five-year senior unsecured notes and $400 million ten-year senior unsecured notes. The $300 million five-year notes are at an interest rate of 4.95% and the $400 million ten-year notes are 5.9%. The proceeds from this offering, together with cash on hand, were used to repay a $700 million, short-term senior unsecured credit facility for predistribution dividend owed to Abbott relating to the spinoff. This gives them a rather high 86% debt/equity and a 53% debt/capital.Interest expense for 6 months was $2.68 million and operating cash flow was $219.5 million--enough to cover interest expense of $2.68 million and capex of $108.3 million.
Performance
With only 6 short months to analyze, there is not a lot of track record here to look for trends.
Income statement quarterly ratios
June 04 March 04
growth revenue 7% --
growth gross income 25% --
growth EBIT 35% --
growth net income -28% --
growth EPS -21% 2%
gross margin 32% 27%
operating margin 17% 14%
gross net 9% 14%
growth COGS 1% --
growth SGA 16% --
Curtailment of post-retirement medical and dental benefits ($64.636 M ) --a one time credit deleted from EBIT, net income and EPS-- made growth quarter to quarter in those numbers negative. It gave a big, unsustainable boost to operating income and earnings. By rights it should be eliminated. It most likely won’t happen again. Gross income, not affected by the one time gain, grew a respectable 25% with well controlled COGs.
Growth in revenue was less impressive, but if we extrapolate to an annual figure, they may produce in excess of 20%. Decent growth for this spinoff. EPS and net income are lower than the Mar 04 quarter, mostly due to doubling of taxes paid and increased SG&A. The annual tax rate is estimated to be 24%. The $51 million paid in the 4th quarter was a 29% tax rate.
Now that Abbott is not picking up administrative cost for all functions( finance, legal, audit, HR, public affairs), Hospira is putting these expenses in place and the cost is rising. We might look for this to decline as the infrastructure related to the costs is put into place. In the last 6 months, they paid Abbott $10 million to provide these services on an interim basis. There is a markup associated with this and SG&A may be a place where costs are trimmed in the future.
Consensus estimates predict EPS around 31¢ next quarter. If the market doesn't correct for the $64 million pension gain, this is going to look terrible compared to the June 04 quarter. Hard to tell how smart the market is. My guess is if they meet or exceed this, it will be a positive and the price may rise. If the market is stupid, 31¢ will look like a decline in earnings.
Hospira is doing better as a spinoff than they were as part of Abbott in the June 04. They are aggressively entering generic drugs and committing money to R&D. R&D grew 16.6%. This should help push growth.
Management has estimated that net sales grew 2.8%(June 04) over the same quarter as part of Abbott in 2003. Gross profit grew 20% and gross margins increased to 32% from 27% due to a better product mix.
With the segment breakdown from Abbott, sales growth for hospital products is available. Growth was unimpressive but steady. Hospira appears to be performing better as a spinoff. Net sales for the June 04 quarter increased 2.8% yoy (annual approx 12%?) compared to 8% annual growth at Abbott. The six month sales were a rather anemic 0.5%, mainly impacted by a softening dollar. The first quarter was much slower with a net sales decrease of 2% due to currency exchange, volume decline in sales to Abbott and lower prices on products. Part of declining sales was due to the cost of bulk ingredients. Formerly, Hospira charged Abbott for the bulk material used to manufacture medications. Now Abbott supplies the bulk ingredients and Hospira can charge only value added processing. This took 25% out of sales. How will this be made up in the future? They don’t comment. As the quarters roll along YOY comparisons will improve. That is already apparent in the second quarter, which was much better than the first quarter.
From Abbott 2003 2002
Specialty Injectable -2% 7%
Pharmaceuticals
Medication Delivery Systems 1% 2%
and Critical Care Devices
Hospital Pharmaceuticals 9% 16%
Quarterly balance sheet
June 04 March 04 Dec 03
current ratio 2.2 2.8 3.0
quick ratio 0.4 0.0 0.0
AR growth -2% 3% -
inventory growth -2% -4% -
payables growth 16% -10% -
DSO 43.1 47.3 -
inventory days 77.6 84.8 -
payable days 21.8 19.0 -
CCC 98.9 113.1 -
debt/equity 86% 0% 0%
debt/capital 53% 0% 0%
The company has controlled accounts receivable growth and days sales outstanding are very good. The inventory turns appear to be improving. The cash conversion cycle is improving. They were debt free but needed to pay Abbott so took on a modest amount of debt. They are fairly liquid without being asset heavy in the wrong places.
Cash flow
They are operating cash flow positive and freecash flow in the June 04 quarter (op cash flow -capex) was $111.2 million.
Evaluation
Assumptions
15% growth for 8 years
Transition for 4 years
Stable growth 3%
beta 1
Cost of equity 9.7
Capex exceeds depreciation by 150% in stable growth(includes R&D)
WC, capex and depreciation grow at same rate as co
I only gave them an EPS of $1.50--they could do better for the year.
The free cash flow to equity is $0.70--pretty good for a new company. This FCFE includes a big deduction in the form of noncash working capital. It also includes a 35% debt ratio and deducts for capex. For Hospira, I haven’t capitalized R&D. They are so new, annual R&D figures with appropriate amortization are not calculable.
Present value of free cash flow high growth is $9.02
Present value of free cash flow transition phase is $6.23
Present value of terminal price is $22.90
Intrinsic value of Hospira is $38.15 by this model.
Tangible book value is $756.9 and per share= $4.85
P/BV= 6.6
HSP APPX BAX BDX
Market Cap: 4.98B 1.96B 18.91B 13.15B
Gross Margin: 32% 52% 41% 49%
Oper. Margins: 16% 20% 9% 15%
PE: 15 39 28 24
PS: 1.89 5.43 1.98 2.65
P/BV 6.6 6.97 5.08 4.27
ROE 15%* 19% 19% 19%
ROE for HSP based on 6 mos earnings only--not full year as others are
APPX = American Pharmaceutical Partners Inc
BAX = Baxter International Inc
BDX = Becton, Dickinson & Co
The company is not a value by the P/BV figure. Although they are not far out of line compared to competitors. Book value should increase as a $75 million payment due to Abbott is finally taken off the balance sheet and debt is paid down(notes due in 2009,2014) Present P/BV is high.
The P/E at 15 compares favorably.
Intrinsic value puts them at a slight discount, although not enough margin of safety is there for a value investor looking for a 50¢ dollar.
Perhaps because they are a relatively successful spin off with unknown potential, they more comfortably fit in the growth category and are at least trading at something of a discount with a reasonable P/E(unlike a lot of momentum stocks that have yet to have earnings and whose price keeps climbing--Overstock come to mind).
The price at $31.91 is disappointingly close to the 52 week high--could have been bought for $24 not long ago. Would be looking for some point to buy in if they give a price break.
Catalysts
**New stand alone entity with decent earnings potential and increasing growth last quarter.
**Spinoff pricing inefficiency holds the potential for above average investment returns over time. Has that ship sailed with the low of $24 giving way to $31? I would be watching for any sign of weakness
**Hospira is in effect a new issues with no underwriter hyping the price.
**Historically spinoffs have 5 times the likelihood for being acquired.
**Hospira is now a pure play hospital supplier and as such, has more appeal to Wall Street. Look back at Zimmer's success after spinoff from BMY
History shows us spinoffs on average have outperformed the general market (S&P 500).
**The next two quarters may be better. HSP is in the hospital business and between November and April, hospital admissions increase. Injectables, maintenance solutions and nutrition should see demand increase. Capital spending for expansive equipment may not see as big a jump. Combine the normal increase in admissions with a population that has been shorted on flu vaccine, and HSP may have higher sales in the next 6 mos.
**Amended existing medication management (pump) agreement with Consorta to enable its members to sign multi-year agreements with Hospira that extend beyond the current contract’s August 31, 2007 end date.
**Launched a new generic injectable drug, deferoxamine mesylate, adding to a position as a provider of generic injectable pharmaceuticals in the United States.
**Completed the process started earlier this year with Novation on a pharmacy contract, and secured its renewal. The contract represents over $200 million in potential annual sales for generic injectable drugs.
**Acquired a 100,000 square-foot manufacturing facility, providing Hospira with additional capacity in emulsion technology.
**Covered by only 5 analysts
Catalyst
**New stand alone entity with decent earnings potential and increasing growth last quarter.
Spinoff pricing inefficiency holds the potential for above average investment returns over time. Has that ship sailed with the low of $24 giving way to $31? I would be watching for any sign of weakness
**Hospira is in effect a new issues with no underwriter hyping the price.
**Historically spinoffs have 5 times the likelihood for being acquired.
**Hospira is now a pure play hospital supplier and as such, has more appeal to Wall Street. Look back at Zimmer's success after spinoff from BMY
History shows us spinoffs on average have outperformed the general market (S&P 500).
**The next two quarters may be better. HSP is in the hospital business and between November and April, hospital admissions increase. Injectables, maintenance solutions and nutrition should see demand increase. Capital spending for expansive equipment may not see as big a jump. Combine the normal increase in admissions with a population that has been shorted on flu vaccine, and HSP may have higher sales in the next 6 mos.
**Amended existing medication management (pump) agreement with Consorta to enable its members to sign multi-year agreements with Hospira that extend beyond the current contract’s August 31, 2007 end date.
**Launched a new generic injectable drug, deferoxamine mesylate, adding to a position as a provider of generic injectable pharmaceuticals in the United States.
**Completed the process started earlier this year with Novation on a pharmacy contract, and secured its renewal. The contract represents over $200 million in potential annual sales for generic injectable drugs.