2 Stocks to Buy, 2 to Sell in Medical Appliances

And as a bonus, here's what to do with sputtering Intuitive Surgical

2 Stocks to Buy, 2 to Sell in Medical Appliances

It was only a matter of time before one of the hottest products in the medical appliance industry would come under fire for safety concerns.

Intuitive Surgical’s (NASDAQ:ISRG) da Vinci Surgical System, which costs $1.5 million per machine, has been the subject of at least 10 lawsuits in the past 14 months. Those lawsuits have prompted the Food and Drug Administration  to investigate whether Intuitive’s robotics are a serious threat to patient safety.

The FDA’s involvement, along with some other concerns, has ISRG’s stock down 14.7% in the past month and 8.4% in the last year — 25 percentage points worse than the S&P 500.

But where does ISRG compare to other medical device manufacturers? Here’s a look at two buys and two sells — plus a verdict on what you should do with ISRG stock.

Buy #1: Sirona Dental Systems

The next time you visit your dentist, be sure to look around the room. There’s a good chance that some or all of the equipment your dentist uses is manufactured by Sirona Dental Systems (NASDAQ:SIRO), a New York-based company that’s grown from $39 million in revenue in 2003 to just under $1 billion in its latest fiscal year ended September 2012. In less than a decade, it has become a dental industry powerhouse.

Sirona’s revenue diversification is what makes itsuch a good company. It generates business from four operating segments: Dental CAD/CAM Systems, Imaging Systems, Treatment Centers, and Instruments. Its CAD/CAM and Imaging Systems accounted for 70% of its overall revenue in the first quarter ended December, 2012.

Thanks to the introduction of its new Cerec Omnicam scanning tool, its CAD/CAM business grew by 16.5% in the first quarter, making the segment not only the biggest growth area for the company but also its most profitable. Continued success of Omnicam will mean continued growth on the top- and bottom-line.

Sirona’s stock isn’t cheap. Since its low of $9.88 in December 2008, the stock has gained 615%. Year-to-date it’s up almost 10% on top of a 46% increase in 2012. But consider this: Noted value investor Ruane, Cunniff & Goldfarb is Sirona’s third largest shareholder, owning 5.3% of the company. It’s been accumulating its position since the third quarter of 2011.

Ruane, Cunniff & Goldfarb’s investment alone isn’t especially noteworthy. However, consider that its Sequoia Fund (MUTF:SEQUX), which has an extremely low turnover of stocks, holds about 41% of Ruane, Cunniff & Goldfarb’s total position. A long-term investor like myself can immediately see the benefit of owning Sirona’s stock well into the future.

Buy #2: ResMed

According to recent data, as much as 26% of the population suffers from sleep apnea, and 35% of those cases are moderate to severe in nature. Not being able to breathe while sleeping is no laughing matter.

Sleep apnea is more prevalent in people with obesity, which is a significant portion of the U.S. population. The estimated total cost of obstructive sleep apnea in the U.S. is $165 billion. Therefore, investing in a company like ResMed (NYSE:RMD), whose products help those suffering from OSA, is a good pick, given the demographics.

Financially, you can’t do much better. ResMed’s second quarter revenue grew 14% (constant currency) year-over-year, its 72nd consecutive quarter of revenue growth. If you’re looking for consistency, you can’t get much better than RMD.

Over the past five years, RMD has grown revenues and net income 14% and 19% per annum, respectively. Earnings per share have grown 20% annually over the past five years, yet its stock’s annualized total return in that time is just 15.9%. Over the long haul, stock prices tend to follow earnings. With a net cash position of $658 million at the end of December, it’s no wonder ResMed repurchased 1 million of its shares in the second quarter.

In the past decade ResMed has had just two losing years. This is a great stock for the foreseeable future.

Sell #1: Opko Health

Opko Health (NYSE:OPK) is up 61.6% in the last three months and sits within 3% of its five-year high. Those numbers come in the face of an operating loss of $37 million in 2012, on revenue of just $47 million. In fact OPK has never made money since billionaire Dr. Phillip Frost merged three companies together to form the current company in 2007.

The 71-year-old CEO has been buying a lot of its stock lately, which has something to do with its meteoric rise. In addition, Opko has developed a high-accuracy a prostate test that’s ready for market. Given Frost’s understanding of pharmaceuticals, long-term I wouldn’t bet against him. However, he’s a billionaire and can afford to absorb losses indefinitely. You can’t.

OPK has come too far too fast with no real catalysts to drive it through $10. With a frothy $2 billion valuation (62 times sales), I’d expect its stock to tread water through the remainder of 2013. What happens after that is anyone’s guess, but it’s not for the faint of heart.

Sell #2: Hologic

Hologic (NASDAQ:HOLX) calls itself the “Women’s Health Company,” in part because of its 3D mammography imaging products. In the first quarter ended December 2012, its Breast Health segment saw a small increase in revenue to $220.8 million or 35% of its $631.4 million in overall revenue.

With the introduction of 3D systems, that percentage is likely to increase in the coming years. Hologic believes there are approximately 11,000 digital systems in the U.S. available for conversion to 3D. It expects to ship between 500 and 700 in the next two years. With 20% operating margins, the Breast Health segment is Hologic’s strongest business.

My concern with Hologic’s stock lies with its Diagnostics segment, which acquired San Diego-based Gen-Probe last year for $3.97 billion.

The acquisition added $3.5 billion in debt to a company that, only five years earlier, took on $1.7 billion in debt and the issuance of 132 million shares to acquire Cytyc Corporation for $6.2 billion. Two years later, it was forced to write off $2.3 billion in goodwill impairment.

In other words, it was a dud of a deal, and this one looks even worse, taking its debt-to-capitalization ratio from 33% before the acquisition to 63% after. Hologic hasn’t made good acquisitions in recent memory; both of these will come back to haunt them.

Morningstar gives it four stars, but I wouldn’t touch HOLX with a 10-foot pole. Even though it generates between $300 million to $400 million in free cash flow annually, it will take a good decade to pay down all its debt. And that’s not good when $2.5 billion of it is variable-rate interest.

And Intuitive?

Warren Buffett loves to see his favorite holdings drop in price because it allows him to pick up more. Intuitive Surgical is a great company that is growing free cash flow at a significant rate. If you own shares already, I’d applaud any pullbacks in its stock. If you don’t own any shares, buy some now and then some later if it drops some more.

If you don’t, you’ll be kicking yourself in five years when it’s a $1,000 stock.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/03/2-stocks-to-buy-2-to-sell-in-medical-appliances/.

©2014 InvestorPlace Media, LLC

Comments are currently unavailable. Please check back soon.