Owens & Minor: Not So Healthy (NYSE:OMI)

Shares of Owens & Minor (NYSE:OMI) have seen a real retreat again so far this year. My last take on the company dates to February when the company announced quite a large deal following the momentum and cash influx provided by the pandemic.

Given the company’s history with leverage, this deal felt a bit big and early, making me cautious as quite some good news was priced into the shares.

Some Background

For most of the 2010s, Owens & Minor was a predictable and boring medical distribution business, but its fortunes changed in 2016 as the company acquired Halyard Health’s surgical and infection business. Leverage incurred, lower earnings and no easy solutions made that shares fell to the low single digits in 2019 with the overhang causing big pressure on the shares.

The promise was that the Halyard business was set to create a $10 billion business, as the nature of the business, being mostly distribution, made that margins were low and EBITDA was seen at just $360 million. With leverage posted at $1.5 billion and dividend commitments being high, the situation was quite challenging.

This came as the projections did not come to fruition, with sales down to $9 billion and EBITDA coming in at $300 million, creating quite a challenging situation. Meanwhile, the company sold the Movianto business in a $133 million deal in order to raise some desperately needed cash as the future of the company was truly being questioned.

The pandemic saved the business as the company’s services were in great demand, with fulfillment being a key need to medical distribution at a time when it was so badly needed. This resulted in the company seeing a profit boom, while the company sold some shares as well to further bolster the balance sheet, as the company ended 2020 with just $900 million in net debt. Even as sales fell to $8.5 billion, adjusted earnings rose sharply to $2.26 per share, as shares rose to a high of $50 per share in 2021.

The company initially guided for 2021 earnings to come in between $3.00 and $3.50 per share, but it hiked this guidance throughout the year to more than $4 per share.

When I looked at the shares in February of this year, the 76 million shares traded at $3.0 billion at $40 per share, as net debt of $919 million worked down to a $4 billion enterprise valuation. This was applied to a business which posted $10 billion in sales, valuating operations at roughly 8-9 times EBITDA pegged around $475 million, with the company trading around 10 times adjusted earnings.

A Huge Deal

Given the valuation discussion above, I was curious to learn in February that the company reached a $1.45 billion deal to acquire Apria, as the deal tag rises to $1.6 billion if one includes net debt. With a $230 million EBITDA contribution, Apria is valued at around 7 times EBITDA, more or less in line with the own valuation. Apria is a different animal as it generated $1.2 billion in sales, revealing that a much higher sales multiple has been paid, due to the fact that its home respiratory therapy and sleep apnea products carry much higher margins around 20%, that is on an EBITDA level.

Pro forma EBITDA is set to rise to $650 million following this deal, yet leverage will creep up to $2.5 billion, for a roughly 4 times leverage ratio. With the company reiterating the 2022 earnings guidance at $3.00-$3.50 per share (excluding Apria), earnings multiples seem low, but it was too harsh for me to see the company incurring a lot of leverage again, after it nearly bankrupted the company just two years ago.

For that reason I concluded to not be interested in Owens. It traded at just 12 times earnings earlier this year, as leverage ratios jumped to 4 times, a very high leverage ratio given the financial difficulties of recent. And I have not forgotten about the structural underperformance ahead of the pandemic as well. More so, the question is still what earnings power looks like after the pandemic.

And Now?

After shares actually rose to the $45 mark in March of this year, we see the same shares now trade at just half that level, with shares trading at $22 and change.

Early in May, Owens & Minor posted its first quarter results for the quarter which coincides with the same calendar period. Net debt jumped to $2.42 billion following the deal with Apria, in line with expectations. Following a solid first quarter, the company hiked the full year adjusted guidance by $3.05 to $3.55 per share, although the gap with GAAP earnings is traditionally high, but fortunately not caused by stock-based compensation expenses. The reason for the hike is less impressive: as the hike is entirely attributed to the purchase of Apria, set to add a mere five cents to earnings per share this year. Full year sales are now seen at a midpoint of $10.1 billion, including a $900 million contribution from Apria.

Second quarter results were posted early in August as reported revenues were up just 0.4% to $2.50 billion. That is a huge disappointment with a strong dollar hurting results, as reported revenues outside the Apria deal would have been down of course. Following a $0.96 per share adjusted earnings number in the first quarter, second quarter adjusted earnings fell to just $0.76 per share. This is reflected in the guidance, with full year adjusted earnings now seen at just around $3 per share, which reveals just a $1.28 per share contribution seen in the second half of the year.

With adjusted EBITDA posted at $156 million for the quarter, that reveals that EBITDA for the year is seen around $625 million. That is important as leverage is of course a concern again, certainly as net debt inched up to $2.51 billion following poor cash flow conversion.

With 76 million shares outstanding, the market value of the firm has fallen to $1.7 billion, for a $4.2 billion enterprise value. That now clearly shows that the company overpaid for Apria (at least on a relative basis) with investors apparently waking up to the leverage risk, dollar strength, higher interest rates and normalization of volumes.

Still Avoiding

The discussions above make it abundantly clear. A 7 times earnings multiple based on adjusted earnings looks too good to pass, yet a 4 times leverage ratio in this environment is dangerous, with interest rates rising and the business pressured by normalization of the activities, inflation and a strong dollar.

With leverage issues causing so many headaches so soon after the company has nearly gone bankrupt just two years ago, I am surprised to see the company making a big deal earlier this year. Given this, even with shares down 50%, the risk-reward is not yet interesting enough to get involved in this leveraged situation.