Biosite (BSTE) reported 4th Quarter results below analysts expectations the last week of January. Diluted EPS was 32 cents vs. 38 cents for the “analysts consensus.” Predictably, the stock was hammered, dropping from 32.79 to 28.71 in two days and closed at 27.71 on Friday.
While most of the Wall Street community sees this earnings report as a bad thing (“how dare they miss our forecasts!”) I view this as a potential opportunity to acquire an interest in a promising company “on sale.”
Let’s look at the numbers to see what all the fuss is about:
* Gross margin: 63% of sales vs. 69% of sales in 4Q 2002, due to lower production rates
* Operating margin: 17% of sales vs. 22% of sales in 4Q 2002, due to higher SG&A from European expansion.
* Diluted EPS: 1% growth quarter vs. quarter
Slowing demand, shrinking margins and flat growth are not words you want to hear! So where is the opportunity? Let’s put our journalist hats on (Mr. Buffett always likened good investing to good journalism) and look a little deeper.
So what does the company do, anyway? (You mean there is a real business behind that stock symbol?) It develops innovative diagnostic tools that greatly improve accuracy and productivity in hospitals. The key word here is develops. Their current products are in use in 50% of U.S. hospitals. Even at this level of saturation, their latest product (Triage BNP) saw sales increase by 80% quarter over quarter and 171% for the year. Sales may have been higher, but the production could not keep up with demand, driving inventories below target levels. Where do these products come from? Biosite’s R&D department, which spends 15% of the company’s revenues (anything over 10%, especially for a profitable company, is considered strong.) They have 7 more products in the pipeline, which will be commercialized over the next 4 years.
In addition to the rich product pipeline, the report itself is not as bad as it seems. The extra SG&A expense was due to a European expansion, which will help Biosite enter less saturated markets. The company also reaffirmed its forecast of 20% to 30% profit growth for next year.
All of these facts reveal a rather different story:
Biosite is a company with 60%-65% gross margins, 15%-20% operating margins, despite spending 15% of sales on R&D. Their current products have 50% penetration in the U.S. market, with room to grow in Europe. Despite signs of saturation, the product pipeline has 7 more products coming out in the next four years, and management is looking at 20% - 30% growth in 2004. Oh, and even after the "disappointing" quarter, the company still sports a stratospheric 16% Return on Assets (ROA) for the trailing twelve months.
What about price? This is the good part! After the shellacking, Biosite sells for 11.5 times 2003 operating profit (EBIT), which means a private buyer would get a 9% return on capital, assuming no growth in operating profit. (Did I mention that management looked for at least 20% growth next year?)
Am I saying buy the stock? No!!! We’ve only scratched the surface. I can think of 15-20 more questions that need answers, namely:
* Will margins recover in 2004?
* One of the products is stagnating. Is the pipeline strong enough to make up for it?
* What are competitors doing?
* How are clinical trials doing?
* Is this investment in Europe going to pay off?
The moral of the story is this: A little investigation can produce unexpected – and maybe profitable – results. This is definitely a company to put on my "check in later" list!
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