Over the past couple of years, Arrow International (NASDAQ:ARRO), the maker of disposable catheters and heart assist devices, has been a story of capacity constraints and falling operating margins. Two years ago, Arrow implemented a turnaround program to get the company back on the right track. With Arrow's fourth quarter and fiscal 2006 earnings now in the bag, this is a good time to perform a health checkup.
Sales were up 6% from $454.3 million in fiscal 2005 to $481.6 million in fiscal 2006. Management forecasts fiscal 2007 sales to be up another 7% to 9%. There was strength in both its critical-care and cardiac-care business. Growth was particularly noticeable in the European markets, where sales were up over 12% for the year. The capacity constraints on sales growth seem to be subsiding now that both the new facilities in the Czech Republic and Mexico are up and running.
On the margin front, the story is also improving. For the full year, profit and operating margins both improved from 8.7% to 11.6% and 11.9% to 16.4%, respectively. Although not back to historical levels, the company's return on shareholders' equity improved to 10.5%. I suspect more improvements in margins should come as production ramps up at the new facilities.
I think it's safe to say that Arrow has done a good job improving its business position. The problem (for me) is that the market is overly impressed. I have a hard time getting excited about paying over 20 times forward earnings on what has been historically moderate single-digit sales growth. The margin expansion is appealing, but with competition like Medtronic (NYSE:MDT), Bard (NYSE:BCR), and Boston Scientific (NYSE:BSX), who knows how much of that will be sustainable? And margin expansion is, after all, pretty much the only way Arrow can achieve the 20% earnings growth analysts are predicting for the next five years.
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Fool contributor Matthew Crews welcomes your feedback. He has no financial position in any company mentioned.
