Catalyst Value Loves Medical Action Industries

By Will Ashworth | April 04, 2011 AAA

David Miller, manager of the five-star Catalyst Value Fund (CTVAX), employs a process that focuses on earnings yield and return on invested capital. Miller selects approximately 100 stocks with a market cap less than $1 billion. Over the past three years, it has been a top performer, achieving this success through genuine value investing. One of its Top 10 holdings is Medical Action Industries (Nasdaq:MDCI). While the company is down approximately 22% from last Summer, it still holds some promise.

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Financial Situation
Management has struggled with rising commodity costs, and this has affected profitability. In 2002, its gross margin reached the highest level in a decade at 30.8%. For the first nine-months of fiscal 2011, gross margins were 17.8%. Despite gross margins half those a decade earlier, it's still managing to make money. In the third quarter, it made $2.3 million in net income, despite stagnant organic revenues. In August, 2010, it bought Avid Medical, a provider of custom procedure trays, for $65.2 million in cash, adding $33 million to MDCI's top-line in Q3. It's doubtful that it can ever get back to the margins of old, but if it could deliver 24% gross margins and 10% operating margins, $20 is easily within reach.

Shareholder Equity
It was pointed out in June, 2010 that the company increased book value over a decade at a rate faster than its share price, suggesting its stock was undervalued. The spread was 510 basis points. Today, it has grown to 580 basis points providing investors with an even better entry point. As Miller suggests in a recent Forbes article, "Not many people have the stomach to look at a list of companies that are bad news stories and say, 'Okay, I'll buy that bad news story, that bad news story and that bad news story.'" Not that MDCI is a bad news story, but it definitely isn't Green Mountain Coffee (Nasdaq:GMCR).

Medical Action Industries and Peers
Company Price/Book Ratio
Medical Action Industries (Nasdaq:MDCI) 0.94
Cardinal Health (NYSE:CAH) 2.67
Covidien (NYSE:COV) 2.76
Cutera (NYSE:CTR) 1.21

Stock Price
A public company since 1989, its stock has gone from a split- and dividend-adjusted price of $1.08 to a high of $25.60 in February, 2007, and back to $8.50 today. The question is where it goes in the future. If it can boost its gross and operating margins, it can move up to $20 relatively quickly. Its price-to-book has never been lower. Averaging 2.8 over the past decade, it now trades at one-third its historical norm.

Analysts' expect revenues in 2012 to hit $435 million. However, using the 2012 EPS estimate of 66 cents, net income would be $10.82 million, based on 16.4 million shares; a net margin of 2.5%. This seems extremely low, especially if it is able to hit higher margins. In 2007, it did just that, resulting in a net margin of 6%. The same net margin in 2012 would mean net income of $26.1 million, or EPS of $1.59. That's a forward P/E of 5.3. In 2007, its P/E was five times that. Split the difference (15-times earnings), and we get a stock price of $23.85.

The Bottom Line
Investing is all about odds. While there's no guarantee that Medical Action Industries will hit $23.85, it's still a risk worth taking for many investors. (Find out why little companies have the greatest potential for growth. Check out Small Caps Boast Big Advantages.)

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