Inside: 2012's Best Value Investment
During times of economic uncertainty, investors try to find the safest investments possible. In the present day and age, the European sovereign debt crisis, the US debt crisis, and Middle Eastern tensions rule the publicly traded asset classes. In terms of equity markets, various sectors have been extremely volatile over the course of 2011, the prime example being financial services.
Since July, the financial services sector has been in a tailspin.
Various European countries, along with the US, have had to confront their rising debt. With sudden changes in monetary policy, financial services firms had to change and adapt. Another sector that has been volatile over 2011 is energy.
Health care, however, has been one of the more stable sectors throughout 2011. While many health care companies suffered in July and August, many were able to recover to previous levels by the end of the year. Considering the versatility of the health care sector, some investors may want to consider investments within one of its various industries. For example, health care includes services companies, pharmaceuticals, and life science research firms.
Some investors may be considering large firms like Pfizer (NYSE: PFE) or Merck (NYSE: MRK), while others may be looking for more lucrative opportunities. In this case, small-cap firms may be the best option, as they offer investors the opportunity to invest during early stages of growth. While there are risks involved, like the company becoming dissolute instead of growing, investors could try to find impressive companies with solid growth potentials. One industry within the health care sector is medical technologies, which offers investors a mix of technology and health care.
While biomedical research advances daily, medical devices progress and assist a wider array of patients, across the globe. One small-cap company that focuses on developing and manufacturing medical devices is Cyberonics (NASDAQ: CYBX). Since raising fiscal year 2012's revenue and EPS guidance in November, the company has gained over 5%. Given the immense growth over the latter half of 2011, should investors still consider Cyberonics?
To better understand the company's background and stock performance, Benzinga spoke to Steve Brozak, the President and Co-Founder of WBB Securities. According to Brozak, "Cyberonics' recent performance is an artifact of recent market conditions. It still operates in a niche market and has successfully created unique devices for epilepsy patients, meaning their fundamental characteristics still exist."
Despite positive Wall Street sentiment, prospective investors should scrutinize Cyberonics. On August 15, the company had to recall several units of one of their products due to imperfections in its electrical output. While the mistake may not affect many patients or the company's revenues, it is a negative event that must be considered. For the month after the announcement, Cyberonics' stock has dropped about 10%.
On the recent product recall, Brozak contends that markets have overreacted. "Unlike many product recall situations, Cyberonics realized the problems rather than customers. The company did not sell many units before learning of the defects. I'n the end, costs incurred are going to be minimal and will not affect their bottom line."
Financial Statements Analysis
Cyberonics filed its latest 10-K in June 2011, allowing investors to view fiscal year 2011 results. First, the company increased its cash balance significantly, from $59 million to $89 million. Total current assets increased from $115 million to $152 million. Likewise, PP&E increased from $31 million to $34 million. More interestingly, Cyberonics increased intellectual property assets by $3 million, which may mean that it has several product lines ready to generate revenue. The company also created a long-term investment portfolio of about $5 million.
Cyberonics reached the end of its debt maturity, having $7 million of short-term debt on its books and no long-term debt. The firm accrued minimal amounts of deferred tax liabilities and deferred revenues. Shareholders' equity increased by about $55 million after an increase in paid-in capital and retained earnings.
Cyberonics managed to increase revenues in 2011 by $22 million without inflating cost of goods sold. Additionally, the company's research and development expenses increased by about 35%, perhaps indicating an effort on the part of the company to maximize its product pipeline. SG&A expenses stayed about the same, which may have indicated that the firm did not have to boost costs in order to maximize production and research productivity. Unlike 2010, Cyberonics did not enjoy an earnings increase from income tax provision benefits, but lost $2 million.
The cash flow from operations saw a healthy $7 million increase from 2010 to 2011. Cyberonics lost up to $8 million in cash as a result of an influx of working capital money. Receivables and inventories increased, meaning the company may be experiencing slowing sales patterns. However, the changes are minimal and are better than the 2010 numbers, so it may not mean much. Cash used for investing activities increased from $6 million to $11 million as a result of increased investment vehicles purchased in 2011. Cash used for financing activities was -$7 million, up from -$44 million. This may be a result of a decrease in debt repayment; the company was at the tail-end of its payments in 2011. Moreover, the company repurchased $14 million of shares.
Investors may consider financial metrics to determine Cyberonics' value relative to direct competitors. In terms of value metrics, Cyberonics may appear to be overvalued. Currently, it is trading at higher price/earnings, price/book value, and price/sales multiples than its competitors. For example, its P/E multiple is 31.8 versus an industry average of 16.5. It does, however, operate with a relatively low debt-equity ratio: one that is nearly 0 versus an industry average of 1.
Growth metrics like Revenue growth are positive for Cyberonics, which has a three-year average of 16.3%; competitors average 6.1% revenue growth. The firm also has a higher operating and net margin compared to similar medical device companies. Lastly, the company experienced a 32.6% return on equity this past year, whereas the average competitor returned 15%.
The Bottom Line
Cyberonics is a small-cap company that operates in the medical devices space, an inherently volatile industry. However, investors must remember that the rest of the economy is performing poorly too, experiencing its own fair share of volatility. Investors should also consider the fundamental aspects that may or may not make Cyberonics an attractive investment. Along with Wall Street support, Cyberonics has rallied with insiders and retail investors piling into the stock. Perhaps there is momentum left in the company's stock as it continues to impress the public with its products.
Investors always have to keep up with the news. While Cyberonics does not directly affect the American economy, it may give us a sense of how the health care sector is doing. Traders have to keep in mind that any possible news that affects finance will move markets. As such, traders should keep up with real-time news via Benzinga Pro in order to act quickly when new developments occur.
Shares of the company are currently trading at $34.30, up about 10.5% for the year.
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Traders who believe that Cyberonics will thrive in the future might want to consider the following trades:
- Long Cyberonics via stock or call options, as continued success will pump up stock price. Cyberonics' stock currently appears to be close to a technical support level, so now may be a good time to buy.
- Short a direct competitor such as EnteroMedics (NASDAQ: ETRM) in order to accentuate positive sentiments about Cyberonics or to hedge a CYBX position. One thing to note, however, is that these two companies both operate in the same industry, so they may move in a similar fashion with the rest of the med-tech companies.
- Investors may want to invest in an ETF, like the Health Care SPDR (NYSE: XLV). This would encompass the entire health care sector and would cover both large-cap and small-cap companies. If investors were absolutely sure about Cyberonics, however, they could long CYBX and short XLV as a hedging strategy.
Traders who believe that the Cyberonics will not succeed in the future may consider the following positions:
- Short Cyberonics at around the $34 level, which is currently a technical support level.
- Investors may favor a large-cap competitor such as Medtronic (NYSE: MDT). This company may be more resilient to volatility in medical technologies industry and the health care sector as a whole.
- Long precious metals, as traders may fear global instability if macroeconomic factors like European debt or Middle Eastern troubles worsen. They may flock to safe havens like gold or silver.
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