2 Stocks with Rising Margins

10/08/2012 11:00 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

In a slow-growth economic world, stocks that can find a way to grow quarter after quarter promise a lot of upside with growth returns, observes Richard Moroney of Upside.

Investors will often pay up for what’s in short supply, and the number of companies with rising margins seems likely to shrink in coming quarters.

The two recommendations below seem capable of increasing profitability. Both have expanded gross, operating, and net margins in at least three of the last four quarters.

Rising medical utilization rates should benefit Bio-Reference Laboratories (BRLI), one of three publicly traded, full-service labs in the US. In an industry typified by high fixed costs, scale helps drive profitability, putting Bio-Reference at a disadvantage to larger rivals Laboratory Corp. and Quest Diagnostics—but also making it a takeover target.

Operating profit margins, which set an all-time high in fiscal 2011 ended October, have continued to climb this year. To counter rising expenses, Bio-Reference has kept employee costs and bad-debt expense under control.

And the shift into esoteric tests, which carry higher reimbursement rates, drove revenue per patient to a record high in the July quarter.

Improving efficiency ratios suggest profit margins could widen further. The cash conversion ratio—the time elapsed from when Bio-Reference invests in working capital and then collects cash—has declined in two consecutive quarters. Days average receivables—receivables divided by the average day’s sales on credit—has also declined, meaning Bio-Reference is collecting cash at a higher rate. The stock is rated Best Buy.

CACI International (CACI) generates 78% of sales from the Department of Defense, which could tighten its budgetary belt in coming years due to deficit pressures. But CACI could be protected by its concentration in growing and well-funded programs, including intelligence, counterterrorism, and computer security.

At the end of June, the company’s order backlog stood at $7.2 billion, up 6% from a year earlier, of which $2 billion is funded.

In fiscal 2012 ended June, CACI’s operating profit margins reached the highest level since 2007, helped by internal investments that reduced the amount of labor—CACI’s biggest direct cost—required for projects.

Shielding profit margins from inflation, cost-reimbursable contracts represented 44% of fiscal 2012 sales, up from 33% in fiscal 2010. In August, management said it has seen some pricing pressure, but still expected to pry profit margins wider.

Turnover for both fixed assets and total assets are climbing, signaling that CACI is generating more revenue from existing resources. CACI is a Buy.

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