Bard Not So Bulletproof

By Stephen D. Simpson, CFA | July 29, 2011 AAA

Diversified medical device maker C.R. Bard (NYSE:BCR) does not often get a lot of attention from small investors, but it has long been a popular name with institutional investor. The company has a long track record of consistent topline growth and one of the best histories of return on capital in the sector. Because of its consistency, its execution, and its well-diversified base of business, Bard has carried a premium valuation for some time.

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Thursday's earnings shook up that idyll. Bard missed on both the top line and gross margin, and the company's vulnerability to the U.S. market once again came front and center. Perhaps, then, those shorts (Bard had an unusually high short ratio going into these earnings) had the right idea.

Disappointing Second Quarter Results
Bard does not often disappoint, and that surprise is likely a big part of the post-earnings reaction in this stock. Revenue growth came in at better than 7% as reported, but 5% on a constant currency basis and just a bit over 3% on an organic basis. Going a step further, the problems were largely in the U.S. - growth in the U.S. was just 3%, while constant-currency growth outside the U.S. was 10%.

Bard's vascular business was relatively strong with 11% growth and oncology posted decent 6% growth. Surgery was up just 3%, though, and urology was flat. While one quarter does not prove much of anything, these numbers do lend some credence to the idea that rivals Covidien (NYSE:COV) and Johnson & Johnson (NYSE:JNJ) are taking share in markets like surgical mesh and soft tissue repair.

Unfortunately, profitability did not recoup what Bard missed in growth. Gross margin slid almost a full point and while the company gained some of this back through operating efficiency, operating income grew just 5% and the operating margin did slide (though it's still at a level that compares very favorably with the med-tech market as a whole).

Procedures Still Sluggish?
The bright side to Bard's disappointment may be that it seems to stem largely from factors out of the company's control. Companies like Stryker (NYSE:SYK) and Intuitive Surgical (Nasdaq:ISRG) are doing well on a recovery in hospital capital spending, but procedure volumes have not yet rebounded strongly. Investors can see this softness in the results posted so far by Biomet, JNJ, Edwards Lifesciences (NYSE:EW), St. Jude (NYSE:STJ), and even Stryker (in the orthopedics and surgical tools segments). While there is certainly room to grab share and products that address underserved markets are still getting acceptance, regular procedure volume is just simply tracking very slow right now. That's something for investors in companies like Covidien and Boston Scientific (NYSE:BSX) to keep in mind as those earnings come out soon.

Need to Balance the Business
Bard would do well to boost the contribution it gets from its overseas business, but demographics could make this challenging. Medical issues like urinary incontinence, cancer, and peripheral vascular disease are much more prevalent in older people and the populations of emerging markets are notably young. Still, it is hard to believe that Bard couldn't do more here, and perhaps should consider a few targeted overseas distributor acquisitions.

At the same time, Bard may look to U.S. acquisitions for a boost as well. SenoRx has worked well for Bard and companies like Angiodynamics (Nasdaq:ANGO), ICU Medical (Nasdaq:ICUI), or Cardiovascular Systems (Nasdaq:CSII) could make sense relative to Bard's target markets.

The Bottom Line
The biggest risk to Bard is arguably not in the competition or in its pipeline, but rather in the Street's expectations. Simply put, the Street still expects quite a lot from this company in terms of revenue growth and margin improvement. That is not to say that Bard can't meet the expectations, but analysts and institutional investors are notorious for not exactly celebrating "as expected" performance.

Compared to a reasonable outlook for revenue and cash flow growth, Bard is still too expensive right now. Were the stock to sell off another 10%, it would be an interesting idea for GARP investors. As it stands today, though, it is hard to justify buying Bard ahead of names like Covidien, Stryker or perhaps even JNJ. (For related reading, also see Investing In Medical Equipment Companies.)

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