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Questor: Medical gear specialist offers a healthy dividend
ConvaTec 238p
Questor says: Buy
Whatever happened to Vodafone’s Three Musketeers? The three executives who built up the mobile phone operator into a world beater are keeping busy behind the scenes at a variety of businesses.
The numbers man, Ken Hydon, is non-executive at Reckitt Benckiser and Merlin Entertainments, while ex-chief operating officer Sir Julian Horn-Smith sits on the board of Denis O’Brien’s Digicel in the Caribbean and Mikhail Fridman’s Russian operator VimpelCom.
The final member, Sir Chris Gent, made an unassuming return to the FTSE 100 late last year as chairman of ConvaTec, which in October became London’s largest initial public offering since Worldpay and its biggest healthcare float for at least two decades. With a £4.8bn market value, ConvaTec was admitted to the top flight in the December reshuffle.
Glamorous it is not. ConvaTec specialises in colostomy bags, catheters, complicated dressings and insulin tubes. Once part of drugs giant Bristol-Myers Squibb, the business was acquired by Avista Capital and Nordic Capital in 2008 for $4.1bn (£3.3bn) and rolled together with two other firms.
The sector has outperformed the wider market of late but ConvaTec’s debut was subdued. Priced at the bottom of its 225-275p range, at least it got away – last autumn many flotations did not as the pound slumped against the dollar. That must say something about the prospects of the business. Its fans point to growth drivers such as the greater incidence of chronic health conditions, plus the broader demographic shift towards longer life expectancy, which has made fellow FTSE 100 firm Smith & Nephew such a great long-term bet.
The star of ConvaTec’s show is its wound care division, which accounts for a third of sales. Treating ulcers and surgical wounds by keeping them moist with foam or gel has higher barriers to entry than basic dressings and the market is predicted to grow more than twice as fast.
Of some concern is the ostomy division (colostomy for the large intestine, ileostomy for the small intestine) where it is the number three player despite giving up market share for the last decade. Forecasting annual ostomy market growth of 4pc and ConvaTec’s 2.3pc average growth, Goldman Sachs thinks it will take until 2020 before the company is taking back share. What went wrong? Almost everything: a lack of investment in new products, the sales force and marketing. Patients are loyal so a turnaround will be slow.
Fixing ostomy contributes to the wider margin improvement story that ConvaTec is peddling. Analysts at Deutsche point out that an operating margin of 29pc is high compared with other industries, but lags rival Coloplast’s 36pc. It is aiming to improve margins by 300 basis points by 2020 which doesn’t sound too onerous given that will still leave it trailing its 2013 peak.
Will we see shades of Vodafone here because of Sir Chris, who also chaired GlaxoSmithKline? ConvaTec has already hit the acquisition trail, spending €25m at the turn of the year on EuroTec, an in-fill for its ostomy division in France and Benelux. Don’t expect fireworks. Its major markets are well consolidated and the company talks about “disciplined” bolt-ons.
ConvaTec had been trading in something of a twilight zone until last week when HSBC became the first bank not on the IPO ticket to issue research and a 310p price target. More will emerge when annual results are released in early March. It is worth noting its private equity heritage creates an overhang. Nordic and Avista, holders of 43.5pc and 18.8pc stakes respectively, committed to no further disposals for 180 days; the senior management a year.
The stock has begun life cautiously, rising nearly 8pc to 238p since listing. But what ConvaTec lacks in revenue growth versus its peers it makes up for in cash conversion. A dividend ratio of between 35pc and 45pc of adjusted net income is being targeted over time and debt is being paid down quickly. Trading at 16 times this year’s forecast earnings, it is a good long-term play.