One of my longtime favorite stocks and companies is Utah Medical Products (NASDAQ:UTMD), which performed beautifully during the bear market of 2000-2002. Utah Medical is a different kind of growth company, as I explained when I used the stock as a case study in how intelligent capital allocation can produce exceptional growth in per-share intrinsic value.
Indeed, Utah Medical has grown earnings per share by 20% or more for six consecutive years (including 2002) without the benefit of much of an increase in sales. It is ironic, and also perhaps instructive, that such companies are most appreciated by investors in a bear market (the stock climbed from $7.50 on March 20, 2000 to $19.10 per share in December 2002, while the Nasdaq lost some two-thirds of its value). In this year's bull market, Utah Medical is up a respectable 25%, while the Nasdaq is up almost double that.
Score one for the little guy
Utah Medical recently announced some great news, though nothing directly to do with its operations. Back in January 2002, the company won a patent infringement case against a subsidiary of Tyco International (NYSE:TYC). This was followed in September by a formal judgment awarding Utah Medical approximately $23 million in damages and accrued interest. Tyco appealed, but on December 5, Utah Medical announced that the judgment was upheld.
This is a huge victory for two reasons. First, it appears that Tyco will finally have to fork over the $23 million (and perhaps more arising from infringements by Tyco after the January verdict was announced). Second, this should put an end to the time, effort, and legal expense the battle has cost Utah Medical over the past seven years or so. Of course, no longer having to compete against Tyco's infringing product should help Utah Medical as well.
The company's market value should increase by about 14% when it receives the $15 million in cash. Even better, given management's demonstrated ability to properly allocate capital to the benefit of shareholders, it's likely that at least part of the money will be put to work in some intelligent way in fairly short order.
Going forward
The past year hasn't been all champagne and balloons for Utah Medical, however. The most recent third-quarter results weren't glowing. Earnings per share increased 6% to $0.38, but sales were down 3%, while operating profits and net income were down slightly as well.
International sales were the big culprit, declining 11% in the quarter, which was a surprise to me, as the company had reported strong international sales earlier in the year. In light of the slower-than-expected third quarter, CEO Kevin Cornwell noted that the company might end the year a bit shy of its $1.55 per-share earnings target for 2003.
In addition to the sales decline, the company's usually impeccable working capital and inventory management suffered a little this year. In the 10-Q filed on August 14, the company noted that:
Inventories increased due to preparation for anticipated increased demand as a result of the injunction against Tyco/Kendall for its infringing product, and the possibility of better access to physicians in hospitals as a result of new GPO codes of conduct prohibiting bundling of "physician preference" products with unrelated products.
Unfortunately, the expected increase in demand did not materialize. The most recent quarter's balance sheet shows that inventories are still not entirely worked down -- the Sept 2003 balance sheet shows inventories of $3.65 million, or 18% higher than the same quarter last year. The September number was, however, a welcome improvement over June's $3.86 million, which was the highest level I'd seen at Utah Medical going back to 1998.
On the bright side, the company extended its exceptional record of 23 consecutive quarters of year-over-year gains in EPS, on record profit margins -- improving on one of the most impressive profit ratios for any public company. Operating margins came in at 39.9% during the third quarter, while the net profit margin was 27.5%. In addition, cash flow was somewhat stronger than expected, allowing the company to eliminate the line of bank debt taken on last year to finance a share buyback.
Decisions, decisions
From here, the company's future will be determined largely by how management chooses to spend the cash from the Tyco litigation. What to do with a large cash hoard isn't a problem familiar to this company; Utah Medical hasn't let more than a million bucks accumulate in its cash account since 1997. Still, given the track record, there aren't more than a few publicly traded companies I would rather trust to allocate this cash for the benefit of shareholders.
Now that the bank line of credit for the previous share buyback has been paid off, the business should manage to throw off $2 million or so in excess cash per quarter. Priority must be given to making intelligent investments to introduce new products via development or acquisition, but Utah Medical won't make an acquisition unless both the company and the price are right.
Franky, I'd be very surprised if further share repurchases are not forthcoming. Nor, as a shareholder, would I be opposed if management initiated either a quarterly dividend or a one-time distribution. As I pointed out in a past column on Dell Computer (NASDAQ:DELL), share buybacks only create value when the company can purchase its stock at undervalued prices.
This doesn't appear to be a problem here. At around $24, Utah Medical trades at a low double-digit multiple to its annual free cash flow -- attractive relative to the high quality of the business and management's track record of creating shareholder wealth. I figure fair value, using very conservative growth assumptions, to be somewhere in the $28-$32 range, implying 17%-33% upside from current prices. In other words, buying back shares at this price is clearly a viable option.
As always, I'll be monitoring the company's financials carefully for signs of deterioration in the business. But for now, Utah Medical's place in my portfolio -- and among my personal favorite stocks -- is secure.
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Guest columnist Zeke Ashton has been a long-time contributor to The Motley Fool and is the managing partner of Centaur Capital Partners LP, a money management firm based in Dallas, Texas. This article does not constitute a recommendation to buy, sell, or hold any security. At the time of publication, Zeke owned shares of UTMD in client accounts.
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