Thursday, February 12, 1998

VWR Scientific Products Corp.
(Nasdaq: VWRX)
Phone: 610-431-1700
Website: http://www.vwrsp.com
Price (2/11/98): $32 5/16


HOW DID IT DOUBLE?

Scientific equipment supplier VWR Scientific has shown that in the low-margin distribution business, bigger is often better. The company doubled in size after acquiring Baxter Healthcare's industrial business in September 1995 for $432 million. The stock has followed, delivering a three-bagger since then and a Double since July.

Every business is looking to manage its procurement costs and inventories. So distributors who can get volume discounts from manufacturers and offer full supply-chain management functions are in vogue. The Baxter deal allowed VWR to attain the necessary size to compete for such business while offering the potential for margin improvements by merging operations.

VWR has delivered on this game plan. Gross margins declined into the second half of 1996 but have since recovered with the integration of Baxter finished up by early 1997, increasing steadily over the first three quarters of '97 (21.8% to 22.1% to 22.5%). Meanwhile, operating expenses have fallen from 16.9% for the first nine months of FY96 to 15.9% for the comparable period of FY97 thanks to cost-saving synergies between the companies.

In a business with razor thin profit margins, such small changes have led to a huge payoff. Although sales increased just 10% for the first nine months of FY97, earnings per share rose 93% to $0.79.

The only question mark was the substantial debt taken on in the Baxter deal. But a successful November public offering of three million shares at $23 3/4 plus an equal amount of shares sold to its controlling shareholder, Merck KGaA, has now turned a pile of that debt into equity.

BUSINESS DESCRIPTION

VWR Scientific is a leading North American distributor of laboratory supplies, chemicals, and equipment to life science, educational, and industrial organizations. It's also the top distributor of cleanroom supplies and apparel to manufacturers of electronics, medical devices, and pharmaceuticals.

VWR offers 200,000 products from over 2,000 manufacturers through five regional distribution centers and 50 smaller service centers. The company offers just-in-time delivery, inventory management, electronic purchasing, and product tracking services. The company's top competitor is Fisher Scientific (NYSE: FSH).

Merck KGaA has supplied the company with chemicals and other products for over 15 years. When VWR approached Merck to help finance the Baxter deal, Merck acquired a 49.9% stake in VWR, which it plans to maintain. Other VWR insiders owned about 4% of the company prior to the recent offerings.

FINANCIAL FACTS

Income Statement
12-month sales: $1203 million
12-month income: $15.9 million*
12-month EPS: $0.70*
Profit Margin: 1.3%*
Market Cap: $1006.5 million
(*Includes $1.3 million in pre-tax acquisition charges.)

Balance Sheet*
Cash: None
Current Assets: $321.3 million
Current Liabilities: $172.2 million
Long-term Debt: $349.2 million
(*As of Sept. 30, 1997. Excludes $133 million raised in recent offerings.)

Ratios
Price-to-earnings: 46.2
Price-to-sales: 0.8

HOW COULD YOU HAVE FOUND THIS DOUBLE?

In general, scientific research is a growth area experiencing little cyclicality. VWR estimates that the North American market for lab and cleanroom supplies exceeded $7 billion in 1996. The Baxter acquisition meant that VWR was positioning itself to be a key supplier for such markets, delivering everything from test tubes to cleanroom clothes.

Indeed, some studies suggest that deals that double a company's size can often be a harbinger of future market outperformance. The simplest explanation is that such big deals involve more overlapping operations and thus expenses that can be whittled down. The distribution business, in fact, may be the easiest in which to orchestrate such integration.

WHERE TO FROM HERE?

The laboratory and cleanroom supply industries have undergone recent consolidation as distributors respond to customer demands for single-source suppliers. There has also been a trend toward outsourcing supply-chain management functions. Distributors with up-to-date information systems should benefit the most from this. To keep up, VWR plans to spend $25 to $30 million over the next two years to replace its computer systems.

The company should have more than enough cash to handle such expenditures. Earnings before interest, taxes, amortization, depreciation, and acquisition charges jumped 22% to $74.9 million for the first nine months of 1997. The recent stock offerings have been used to pay back $121 million in debt, which should reduce interest payments considerably from the $27.2 million reported for the first nine months of 1997.

The company should also see a last year's fourth quarter earnings loss of $0.09 per share turn into a gain of $0.26 per share for 1997, according to First Call consensus estimates. Analysts expect VWR to report EPS of $1.06 for FY97 and $1.35 for FY98. That puts the stock at about 29 times FY97 estimates and 23 times FY98 estimates with earnings expected to grow by 27% in the year ahead. Assuming the FY97 estimate proves correct, we get a PEG around 1.1, suggesting VWR Scientific is fully valued.

The company has delivered strong margin improvements in recent quarters and the earnings run-rate based on third quarter results is $1.48 per share, suggesting the current estimates might prove low. Then again, with just 10% sales growth, it's hard to believe VWR can deliver better than 20% long-term earnings growth.

-- Louis Corrigan
(TMFSeymor@aol.com)


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