Stock Strategy v.3081.12
This blog post is centered around an analysis of Owens-Minor (ticker:OMI) while explaining why I believe it to be a sound value stock presently. The search for investment options can take a path of numerous methods, and in this case, I used a particular set of criteria focused on identifying undervalued stocks based on cash flow analysis. A value investor’s approach almost always incorporates DCF (Discounted Cash Flow) analysis. I was also looking for a high-quality business with strong internal returns on capital and an attractive valuation, offering a significant margin of safety. At the time of writing this, the broader market has been experiencing bearish sentiment in recent days, which can present opportunities to identify long-term value investments, as the low tide drops all ships. To begin my search for new stock options, I typically turn to finviz.com, using the screener section to narrow down companies that meet my initial selection criteria. These fields and selections serve as the starting point for my stock selection process:
- P/E = Postive
- Dividend Yield = Postive
- Current volume = Over 500k
- Relative Volume = Over 1
- Price = Over $2
Now the screener will itemize a list of stocks that fit the aforementioned criteria. This is where the next step comes in. I select the “charts” tab to give me a visual so I can scan the chart patterns. I’m looking for trade ideas. I came across $OMI as the chart pattern caught my eye. The stock was trading for $14.50 after a post earnings gap down from $20. It continued some light sell volume and fell to around $12 in the subsequent days after the gap down. This situation will occur when a company reports earnings after the market close that is perceived as negative to the public. If the earnings report contains disappointing results relative to analyst and public opinion’s expectation, the stock can open the next day priced down much lower as investors dump and flee. Sometimes we’ll witness a stock drop even when a positive earnings report was released. This because the price of the stock baked in over expectation of anticipated results which lead to a run up in price before the E/R came out.
My next step is to start analyzing fundamentals. I use Yahoo! Finance to look at the statistics on the company. In this case I witnessed several positive indicators about the financial health and progression of the company. Their revenue increase to $9.9 billion for the year, which translated to a 3.3% increase year over year. This is not too spectacular however still considered good given the climate we are in. They are holding a mountain of cash on hand and free cash flow was in the $300 million range. If we minus out the liabilities against the asset values, the tangible book value of the company (taking the total assets subtracting liabilities so if you were to sell the company for its asset value) they have $12.40 per share in net assets. Cash on hand and free cash flow is a tremendous tool in any business that allows them to acquire companies, make changes, or weather any financial crisis. It helps make the case for long term viability and necessary borrowing. The free cash flow yield, which is based off levered cash, is a heavily weighted metric. Even with a booming economy, heavy free cash flow is a tremendous all-purpose asset to any company and can be often seen as a way to determine “make it or break it” in regard to its future viability. When the market is approaching macro economic headwinds, cash creates an extremely necessary buffer to survive the storm.
Next step, I went to sec.gov to pull the recent filings on $OMI, including the recent 10q. This document is extremely important for long term investors, not so much for short term trades. The data contained in a 10q is sort of like road map if you are able to piece together the story. I typically put a keen eye in identifying its short and term risk. Heavy risk can be a huge bulk of what keeps a stock depressed and down for months if not years. Sometimes, it can be the beginning of a road to insolvency. I want to figure out which risks are transitory. Here’s what I found in risk.
Their 3 main risk components are:
- Inflationary pressure
- Supply chain
- Indebtedness and ability to pay on loans and bonds
Disclosed in the recent 10q filing was their inability to raise prices against inflationary pressure. They disclosed that if faced with the decision to raise prices by passing along costs to customers, they would be unable to do so. This is likely from pre negotiated long term contracts with clients. Their supply chain concerns is temporarily hurting net profit and revenue generating capability. Every products based company has been burdened with the same challenges with the hopes of this easing soon. One thing is for certain, this won’t last forever. When this gets sorted, it will bode well for companies like OMI and have a positive impact on their income statement and balance sheet.
I did not see too much open short interest, which is typically a positive sign meaning that investors aren’t expecting a huge downturn in the company since the stock already dropped significantly by 25%. (by the way, this doesn’t matter as much in the long term setting of things). It appears the situation is oversold which induced further panic selling, very typical when it comes to post-earnings report selloffs. So I had to look at the fundamentals and see what was impacting the earnings per share. Although the company’s earnings had dropped from around $2 per share to $0.29 per share after the report, I was hoping to find something that would justify the drop. I discovered that the company had recently acquired a competitor for $1.7 billion in cash, which allowed them to receive $133 million in cash. The company had opened some financing activities to include selling senior notes at 6.2% due in 2030. This bond sale was used to finance the acquisition, which impacted the earnings per share in the short term. Any bonds, covenants, or warrants that may exist in the company’s financing activities is very critical to read over and understand their future impact on the Earnings Per Share. Never overlook this.
However, in the long term, the acquisition is expected to give the company operating leverage as they vertically integrate the two companies. This should strengthen and lower operating costs when merged and allow for net profit, which would theoretically finance the deal, including the 6.2% interest paid on the bond. This was a great thing to uncover. One of the key indicators I found in the report was that even though earnings were down due to the acquisition, I also uncovered what might be causing the decline — the supply chain. As the company dived into risks, the current risks we need to identify and determine whether or not they are transitory, meaning temporary. One reason I found was supply chain issues, which is very common right now, which negatively impacted earnings. Inflation also impacted earnings, as many companies are combating inflation with greater efficiencies in technology performance and raising prices. Again, I feel that this could be short term and will work itself out. Next issue is that the company had recently sold stock and diluted the shares by 11%. This was done with a sale of 8.4 million shares and impacted 11% of the total share count. However, if you look at the company’s historical performance, the stock typically trades in the $40 per share range. An 11% dilution against the company’s total number of shares, mixed with the extreme price drop is a grossly over exaggerated decay in price not equitable with the new share count. Meaning the stock price oversold much lower relative to this negative news. This is known as “price discovery” as the investor mix sells off, buys in, volume is spread and its price hasn’t quite landed yet. The recent acquisition caused some investors to flee given its temporary adverse effect on the financials. Longer term, this will be a sound and strong move for the company and generate strong returns on capital.
It is important to note the historical performance of a stock. How does it absorb positive and negative economic situations. How has it historically stacked against perform of the S&P 500? The Beta value of the stock over a 1 is a trailing indicator of greater performance against the S&P 500. Assuming there are no major losses to divesting operations, obsoleting technology, patent violations, etc (in other words, adverse semi permanent disruption to revenue generating capability). This stock has been very good at maintaining excellent earnings power and a higher price of the stock (relative to todays current price) with stable gyrations and without routinely breaking down past key price support line thresholds on the chart. In fact, this stock hasn’t been this low in over 10 years (please note: NEVER let that be the reason to buy, just making a point. Incorporating this into my analysis, I would give this a lower weighted value than other key fundamentals I look at).
Keep in mind that just because the stock is down doesn’t always mean it’s going to go up. But in this case, this company has been around since 1882, carries a load of cash on hand, and is a power player in their industry, so the prospect of insolvency is low. They operate in a growing industry — healthcare. The baby boomer population is very large and aging, and as time goes on, healthcare facilities such as hospice centers are growing in numbers. So we know that healthcare, coupled with population growth, will continue to be a much sought out industry. When I look for value plays such as OMI and for long-term deals, I couldn’t imagine not diving into the most recent quarterly report, the 10q report, or the annual report (10k). There is a lot of concrete detail that the company discloses about its current performance, future performance, and where they’re going. You can get a really good sense of the risk to this company both short and long. I believe this company is easily worth $17 per share currently with $25-$30 per share target price 1 to 3 years out.
May 5th, 2023 Update: The stock price of (OMI: Owen’s & Minor) gapped up to a intraday high of $19.16 before settling to $18.63 at the close of the market. I purchased shares of OMI on March 22nd, 2023 for $12.95 per share. I wrote this analysis and published this blog post on March 25, 2023. My realized gain in 44 days was a 45% return on capital invested.
