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<DAILY TROUBLE>
Friday, July 2, 1999

Omnicare, Inc.
(NYSE: OCR)
Phone: 606-291-6800
Price (7/1/99): $12 3/16


HOW DID IT FIND TROUBLE?

Omnicare shareholders may have been running to the medicine cabinet for some aspirin after the past few months. The healthcare company's stock started the year trading at just under $35 per share before starting to look a little sickly. One problem that has been plaguing the drug distribution industry in general, and Omnicare specifically, is the change in the way Medicare is paying bills. The new Prospective Payment System (PPS) cuts Medicare reimbursements, which has had a chilling effect on many companies throughout the supply chain as worries about future profits start to come forward.

Investors in Omnicare didn't have to wait long for the effects of PPS to hit the company. On June 17 Omnicare announced that, largely due to PPS, it would report quarterly earnings of only $0.25 to $0.30 per share, below the $0.34 per share Wall Street analysts were expecting. As typically happens to companies that pre-announce they will miss their estimates, Omnicare was absolutely punished. On extremely heavy volume, the stock tumbled more than 25% that day, to its lowest level in five years.

Debt-rating firm Standard and Poor's also downgraded the company's outlook from "stable" to "negative" after the profit warning was announced. While the volume has remained relatively high since the earnings warning and debt downgrade, Omnicare's stock has stayed in a fairly tight range in the low teens. This has anyone who bought the stock over the past few years saying, "Ouch!"

BUSINESS DESCRIPTION

Omnicare is based in Kentucky and is the largest independent provider of pharmacy and related services to nursing and assisted-living homes. The company dispenses drugs and provides medical record-keeping and billing services for about 617,000 patients in 8,600 facilities in 43 states. It also provides a variety of other related services to its clients, such as drug therapy evaluation, drug administration monitoring, and regulatory compliance consulting.

One way Omnicare has become such a large force in the sector is buying and "rolling up" smaller pharmaceutical service firms. By eliminating redundant operations and through economies of scale, Omnicare is betting that one large firm can provide services much less expensively than a smaller company can on its own.

Omnicare also provides contract services for other biotechnology and pharmaceutical firms that need help with governmental compliance or product development, research, and marketing. In the most recent quarter, the company's contract research segment generated only 7.6% of Omnicare's total sales, with the balance coming from the company's pharmacy services.

Omnicare is a member of the S&P 400 MidCap Index.

FINANCIAL FACTS

Income Statement
12-month sales: $1,622.8 million
12-month income: $87.8 million
Profit Margin: 5.4%
12-month EPS: $0.98
Market Cap: $1107.6 million

Balance Sheet
Cash: $71.4 million
Current Assets: $666.2 million
Total Assets: $2,003 million
Current Liabilities: $237.2 million
Long-term Debt: $711.2 million
Total Liabilities: $1,002.6 million

Ratios
Price-to-earnings: 12.4
Price-to-sales 0.7
Price-to-book: 1.1

HOW COULD YOU HAVE SEEN IT COMING?

With the stock's slow but steady decline through much of early 1999, it's probably safe to say that many investors saw the hiccup in profitability coming due to the Medicare reimbursement changes. As PPS and its lower reimbursements started to be implemented, it would only make sense that Omnicare would see some of its demand disappear. Since nursing homes are Omnicare's primary clients, as well as one of the largest recipients of Medicare funds, making the connection between reduced Medicare expenditures and lower profits for Omnicare and its peers would not have been that difficult.

Even if an investor did not make the connection between Omnicare and Medicare's new practices, a look at the balance sheet could have given some clues that Omnicare was headed for turbulence. Because of the company's aggressive acquisition strategy, long-term debt has more than doubled over the past year. While the acquisitions may prove to be profitable down the road, the increased leverage raises the risk to equity holders and can amplify minor problems, such as the Medicare situation, into major ones.

WHERE TO FROM HERE?

There's no question that Omnicare and its competitors, such as NCS HealthCare (Nasdaq: NCSS), are out of favor at the moment. Omnicare is, as of this writing, trading at less than 13x trailing profits while NCS is at less than 8x trailing earnings, compared to the 34x earnings the rest of the market is currently trading at. While some of the discount is certainly warranted with the uncertainty of future Medicare funding, there's no doubt that the company is trading on the cheap.

The whole question of where Omnicare is headed comes down to whether the market is making a mountain out of a molehill concerning Medicare funding. There will no doubt be an impact from the ongoing changes, but how large will the impact be? Even though no one really knows what will happen with Medicare, one certainty is that the population will continue to get older and grayer as the years go by, directly growing Omnicare's primary market.

Even with the new watered-down earnings estimates, the company is still expected to earn $1.27 per share in 1999 and $1.53 in 2000, putting the stock at under 10x forward earnings estimates. The stock is also barely above its book value at the moment, which should certainly attract the attention of some bottom-fishing value investors.

While the decline in the stock price has essentially closed the door for Omnicare to acquire companies using its equity, the company is still looking to roll up smaller firms into its portfolio. If Omnicare is to regain favor on Wall Street, it must continue to realize synergies and efficiencies related to its recent acquisitions.

The fundamental operating environment of Omnicare may be quite negative at the moment, but the company does have an impressive history of growing while retaining profitability. Omnicare has increased both its top and bottom lines for each of the last five years, going from $159.6 million in sales in 1993 to the $1,622.8 million recorded in the past twelve months. Looking at Omnicare is certainly prescribed for those who think the Medicare scare has been overblown and like fishing for solid companies that are down on their luck.

-- Paul Larson (TMFParlay@aol.com)

Make a Living Foolin' Around.

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