Hill-Rom: Litigation Equals Opportunity For Investors

By Will Ashworth | December 23, 2011 AAA
The year was coming along nicely for Hill-Rom Holdings (NYSE:HRC), one of the world's leading hospital bed manufacturers, when it announced its third quarter earnings on July 27 after the market closed. Included in the financial details for the quarter was a $42 million litigation charge for the potential settlement of an ongoing lawsuit with the federal government alleging Medicare fraud between 1999 and 2007. While Hill-Rom denies any wrongdoing, the news sent its stock down the very next day from the close price of $43.88 on July 27 to $36.25 on July 28. Considering it was as high as $48.80 before the news of the settlement, investors have an opportunity to own its stock at bargain prices. (For related reading, see How To Decode A Company's Earnings Reports.)

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Fourth Quarter

Q4 revenues grew 7% on a constant currency basis to $431 million, while adjusted diluted EPS was 72 cents, 7% ahead of last year. For the full year, revenues grew 7% on a constant currency basis to $1.59 billion with adjusted diluted EPS of $2.27, which was 29% higher year-over-year. In Hill-Rom's Q4 conference call, CEO John Greisch characterized its year as a good one in which it achieved all of its key objectives for 2011 despite the difficult economic environment in Europe. Excluding $47 million in legal settlements, its operating cash flow of $270 million in 2011 was almost double last year's. Having more free cash in 2011, it repurchased $115.3 million of its stock at an average price of $36.65. Taking advantage of temporary weakness in its stock price, it bought back 1.5 million of those shares at an average price of $30.21 a share. In time, this move should prove to be a wise allocation of capital.

Fiscal 2012

Heading into fiscal 2012, Hill-Rom's North American Acute Care segment has a backlog around 35% higher compared to last year. Despite this good news, management expects to see constant currency revenue growth of between 4% and 5% with adjusted diluted EPS of $2.45 to $2.55. That's a price-to-earnings (P/E) ratio of about 13 times. Clearly, its European business is what's keeping it very conservative in its guidance. If the situation in Europe proves to be better than expected, you're getting an even better deal. At present, management is expecting mid-single digit constant currency growth from its international segment, which is the same as its North American acute care segment. This tells me its business could be stronger than management is letting on. As it stands, Hill-Rom's CFO expects free cash flow of $215 million, which translates into an excellent free cash flow yield of 10.8%. (For more information, read Free Cash Flow Yield: The Best Fundamental Indicator.)

HILL-ROM AND PEERS

Company

EV/EBITDA

Hill-Rom Holdings

6.58

Stryker (NYSE:SYK)

7.10

Invacare (NYSE:IVC)

5.53

Mindray Medical (NYSE:MR)

13.64

PerkinElmer (NYSE:PKI)

8.79

New Management

The federal government's lawsuit against Hill-Rom was initiated in 2005. It's taken more than six years to resolve, and although Hill-Rom claims it did nothing wrong, its settlement was substantial. When purported acts of fraud are hanging over a company, its focus has to falter. Litigation is never a good thing. Originally, former CEO Peter Soderberg was intending to retire in April 2011. That was moved up to January 2010 when Hill-Rom hired John Greisch, a former Baxter International (NYSE:BAX) executive. That wouldn't happen unless the board felt there was a void in leadership created by Soderberg's succession announcement. When opportunity knocks, you open the door. As president of Baxter's international division, Greisch and his management team had doubled sales in China and were successfully developing business in other emerging markets when he suddenly resigned in April 2009. Taking some time off to recharge, a quality executive was available, so the process was moved up 15 months. That was a smart decision. I'm guessing one of Greisch's first moves as CEO was to get this litigation behind the company as quickly as possible. Long-term, it is better for the company to move on.

Bottom Line

Hill-Rom announced December 16 it was buying Volker Group, a German-based manufacturer of hospital bed frames, for $85 million. With free cash flow on the rise, look for more of these small, tuck-in acquisitions to boost growth in the future. At today's prices, you're getting a fantastic deal on its stock. It won't be on sale forever. (For related reading, see Stocks Basics: What Causes Stock Prices To Change?)

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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