Playing the Do-It-Yourself Health Trend

02/18/2009 1:00 pm EST

Focus: STOCKS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Ian Wyatt, chief investment strategist of Growth Report, says a supplier of pregnancy tests and other diagnostic products will profit from a move towards home diagnostics.

Inverness Medical Innovations (NYSE: IMA) engages in the development of consumer medical diagnostic products. Specifically, the company is a supplier of consumer pregnancy and fertility tests and other rapid point-of-care diagnostics. It also offers a range of vitamins and nutritional supplements.

Inverness Medical is profiting from the growing home diagnostic trend. The company has taken its products global and is looking to add more monitoring systems to its pipeline. Management has a proven track record in technology and innovation and also has a significant equity stake in the company.

[Potential drivers of growth include] growing political support for health-care reform; [the fact that the] health-care system is trending away from an activity-driven reimbursement system to a quality-driven reimbursement system; [the growing importance of] wellness testing in reducing overall health-care costs, and Inverness’s defensive growth-stock [characteristics].

In the third quarter ended September 30, 2008, Inverness Medical recorded revenues of $438.8 million, [up] from $237.6 million in the third quarter of 2007. The company attributed the increase primarily to revenue provided by the health management segment, along with $63.5 million of incremental revenue contributed by recently acquired businesses. The net GAAP loss was $3.7 million, or 12 cents per diluted common share, from a net loss of $3.74 per share for the third quarter of 2007. The company reported a cash and cash equivalent balance of $154 million.

The company is difficult to value, mainly because most of its growth has come through acquisition. As a result, projecting future sales and earnings can be tricky. Additionally, sales on a GAAP basis are negative. An easy way around using traditional earnings metrics is to look at the company's cash flows and non-GAAP income.

Here we see that the company actually earned $1.27 in 2007 and is expected to earn $1.97 this year. Throughout the past three years, Inverness has managed to grow cash flows to $88 million in 2007, from $34 million in 2006 and $26 million in 2005.

We will use non-GAAP earnings per share (EPS) estimates to value the stock. This method removes one-time items and acquisition-related costs. We project that the company will earn $1.98 this year and grow earnings 29% to $2.56 in 2009.

Shares currently trade at ten times our 2009 EPS estimate, which is shocking. Fair value for such a company is at least 16 times forward earnings, but we understand the uncertainties in the market place, as well as the uncertainties commonly associated with acquisitions.

Accordingly, we are depressing our fair value multiple down to 12.5x, which results in a one-year target price of $32. (It closed above $25 Tuesday—Editor.)

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