One of the strongest stock picks of my stock model this month has been Varian Medical Systems (VAR), which provides radiation technology solutions that assist doctors treating cancer. Shares are up 7.2% for my subscribers in March so far, which will just about pay for six hours in the hospital. I still recommend it on dips for growth investors.
Some of Varian’s products include treatment simulators, X-ray machines and treatment planning software. It sells directly to physicians practices as well as to hospitals and cancer clinics worldwide, and has migrated up to the high end of equipment, including stereotactic radiosurgery and image-guided radiation therapy, which focus intense radiation on tumors while sparing surrounding tissue from the rays.
Varian’s equipment is costly, and once it is in service the switching costs are very high, so doctors tend to choose to just upgrade its equipment rather than consider competitors’ lines. The high level of return in equity and profitability shows that the business model is strong, though like any medical business it faces price pressure in lower reimbursement rates from insurance companies and the government.
Morningstar analysts point out that earlier this year, the Centers for Medicare and Medicaid Services attempted to change the reimbursement formula for free-standing cancer clinics as part of a growing movement to control health-care inflation. While CMS backed down eventually, lower reimbursements are still likely to come in the future. Also, the competition is not standing still, as radiation therapy is a segment of the industry that has attracted a lot of rival devices.
Current market cap is $6.5 billion, which puts it squarely in our sweet zone: the mid-cap camp. It’s been growing at least 17% annually for the past five years, and is not expected to slow down much. Consensus estimates for fiscal 2011 is for earnings of $3.14 per share; my model would put the number at morel like $3.39.
If that’s the case, the forward price/earnings multiple is 15x, which is a little low for a company that has grown in the high double-digits as steadily as VAR; the industry average is 23x. So if we figure that investors will come to give the stock a PE of 23 in the next year, then there’s upside to $77 over the next 18 months, which is 43% higher than the current quote. The company traded at $65 as recently as mid-2008, so that’s not too far-fetched. The next best entry into VAR will probably be around $51.50.
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